Dividends for Your Dreams

Kermit Weeks has a great life. Because his geologist father asked for a 2.5% royalty from BHP Billiton (NYSE: BHP) in lieu of payment for helping the company find oil, Kermit and his kin are multimillionaires. Kermit's antique airplane collection was even featured in Forbes.

But that can't happen to you, right?

Actually, it can ... with dividends.

Be smart with your cash
While BHP still pays Kermit, that money is "less significant than his income from investments." You see, Kermit reinvests his dividends, and that's the secret to supercharging returns.

Reinvesting means you use dividends to buy more stock. It's a simple process, and its effect is overwhelming. While a $1,000 investment in Altria (NYSE: MO) in 1980 would be worth $71,000 today, 25 years of reinvested dividends would make it worth nearly $170,000 (and you'd be earning $7,000 per year in dividends).

Multiply that effect a few times over. That's why Kermit Weeks is living in the lap of luxury.

Make your dreams come true
But you have to be smart when choosing dividend sugar-daddies. And since nearly 3,000 publicly traded companies pay shareholders, that can be a trick. After all, you can't reinvest in a company that goes bankrupt, and no amount of reinvesting could have saved you from Eastman Kodak (NYSE: EK).

The key is to find companies that deliver capital gains and growing dividends. For Fool dividend guru Mathew Emmert, these are growing stocks that generate substantial free cash flow and pay out less than 50% of it to shareholders. Microsoft (Nasdaq: MSFT) fits this profile. So does Kraft (NYSE: KFT). Disasters, on the other hand, loom for companies that can't generate cash. Think Ford (NYSE: F) and General Motors (NYSE: GM).

Even if you have no interest in antique airplanes, living off your investments may still sound appealing. Click here to let Mathew and his Motley FoolIncome Investor newsletter service help you do it.

Tim Hanson does not own shares of any company mentioned. Kraft is an Income Investor recommendation. Microsoft is a Motley Fool Inside Value recommendation. No Fool is too cool fordisclosure ... and Tim's pretty darn cool.