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Monday, September 30, 2013 - 10:00

Paul McCartney's $650 Million Wealth Secret

Monday, September 30, 2013 10:00 AM

In 1965, Paul McCartney wrote a song for the Beatles album "Help!"

Since then this song has been rerecorded by other artists more than 2,200 times, more than any other song in history.

As the story goes, when he sat down at the piano to write the tune, he had a melody in mind. But he hadn't written the lyrics yet. As a result, the working title for the song was "Scrambled Eggs."

Once the lyrics were written, "Scrambled Eggs" became "Yesterday," a No. 1 hit song and one of the Beatles' most enduring classics.

Today Sir Paul McCartney is a very wealthy man. Forbes magazine estimates his net worth at around $650 million.

But here's where it gets interesting...

Every year, McCartney earns almost as much from another song, "Wonderful Christmastime," as he does from the entire Beatles catalog.

Why? Because of his royalty agreements.

He wrote the lyrics and music and played all the instruments on "Wonderful Christmastime." But more importantly, he kept his rights to all the royalties. This one song, released in 1979, has so far earned McCartney roughly $15 million. It continues to generate $400,000 to $600,000 for McCartney every year.

While very few of us will ever write a hit song in our lifetimes, there is another way we can use the wealth-building power of royalties.

As investors, we can invest in a unique type of business called royalty trusts.

A royalty trust is a corporation created to act as the owner of the mineral rights to wells, mines and similar properties. It exists only to pass income generated from the sale of the property's assets (gold, oil, etc.) to shareholders.

No income tax is paid at the corporate level as long as the bulk of income (at least 90%) is passed through to shareholders in the form of distributions or dividends.

As a result, royalty trusts offer investors yields that are generally higher than those offered by stocks and bonds.

Today, SandRidge Mississipian Trust (NYSE: SDT) is currently yielding 18% and is trading near an all-time low:

SandRidge Mississippian Trust owns a royalty interest in oil & natural gas properties leased by SandRidge Energy (NYSE: SD). It's entitled to 90% of the proceeds received from sale of oil & gas production attributable to SandRidge's net revenue interest.

So what gives? By looking at the chart alone, the company looks like a disaster.

Well, the underlying company, SandRidge Energy, has had a rough time over the past several years. This parent company has been divesting what some analysts consider prime assets and running up a boatload of debt.

And there has recently been a revolt among board members and shareholders at SandRidge over the tenure of former CEO Tom Ward.

After Ward was fired this summer, Forbes called Ward's $90.9 million severance package "one more giant black mark against the American system of corporate governance" and said his tenure as CEO "gives 'paid to fail' a whole new definition."

Harsh words. But here's the failure they're talking about...

Since Ward brought SandRidge Energy public in 2007 its stock value has fallen over 80%. And since the June 2008 all-time high of nearly $70 there has been over a 92% depreciation of the shares.

But here's the thing...

While SandRidge Energy has been getting a lot of bad press, Sandridge Mississippian Trust has been doing quite well.

The trust was formed in December 2010 and owns royalty interests in oil and natural gas properties owned by Sandridge Energy in the Mississippian formation. (The name is a bit misleading, as the properties owned by the trust are not in the state of Mississippi. The wells are spread throughout five counties in Oklahoma.)

The trust delivered strong performance in this year's second quarter, with volume up 20% over the previous quarter and almost 90% year over year.

The year-end 2012 reserves value (assets still in the ground) of SDT was $508.3 million. Yet the current enterprise value of the company is only $374 million.

Another remarkable set of metrics are SDT's return on assets (ROA) and return on equity (ROE). Over the past 12 months, the company has boasted a 28% ROA and 28% ROE, compared with an industry average ROA of 2% and an ROE of 4%.

Based on these numbers, fair value for SDT should be around $18 a share -- roughly 30% upside from today's share price of $13.

Recently, Forbes noted that shares of SDT had entered oversold territory. In other words, the negative headlines are already baked into share prices. New management is in place, and the sellers have sold. I don't see too much downside risk at these prices.

Risks to Consider: Like all trusts, SDT's assets are finite and will run out eventually. Although analysts predict that SDT's assets will last for at least the next decade, the trust will eventually be dissolved. This is not a stock you can hold "forever."

The tax implications of investing in royalty trusts are complicated. Distributions from U.S. trusts are taxed as regular income rather than at the lower 15% dividend tax rate, and investors may have to file tax returns in the states where the trust operates.

Action to Take --> Buy at today's price and set a target for $18 over the next 12 months. Collect an 18% dividend while you're waiting.

P.S. While Dave Forest has his eye on the next big oil and natural gas opportunities like SandRidge Mississippian Trust, he recently told subscribers of his Scarcity & Real Wealth newsletter about a gold miner that he thinks has fallen too far compared to the price of gold -- especially when you consider that it's one of the top low-cost producers in the sector. Out of fairness to subscribers, we can't reveal the name of the company here. But to get all the details, click here.

Chad Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.