The Cheater's 6-Bagger

Quick Jeopardy quiz: The stock market owes 40% of its historical returns over the past century to this.

Answer: What are dividends, Alex?

Correct!

Whither pennies?
I'll bet many of you knew the answer immediately. You're smart. You're Foolish. So why do you even look at penny stocks?

Oh, come on, admit it. You know you do. You stare wide-eyed all the time at issues trading for less than a buck. Your so-called muse whispers "10-bagger" as you begin to pant and sweat. You envision yourself a master investor -- the Warren Buffett of penny-stock-land. Before long, your trembling fingers are pounding the keyboard, and you're screaming, "Buy! Buy! Buy!"

Months later, those penny stocks are down 80%, and your screams are of portfolio agony. How did it all happen?

A cure for your speculative disease
The answer, Fool, is simple: You forgot that the vast majority of the market's multibaggers became multibaggers over time by paying dividends that investors then reinvested. That's right -- it's so easy, it might as well be cheating. But most investors forget this truism, which is why Jeremy Siegel's The Future for Investors is such an important book. He uses more than 200 years of stock market data to prove that cheating -- that is, dividend growth investing -- is simply a superior strategy for stalking the multibagger.

You know what else? Recent history also proves him right. Take Advanced Micro Devices (NYSE:AMD), for example. This upstart chip maker has seen big gains in recent years as it has taken the fight to Intel (NASDAQ:INTC) and gained market share. It doesn't pay a dividend, but its 10-year average annual return is a respectable 13.3%.

AMD happens to be one of those rare growth stocks that has delivered on the hype. Accordingly, its 10-year return should blow away that of most other pedestrian issues, even the ones that pay dividends, right? You'd think so, but that's simply not the case. Below are five stocks that have juiced their payouts an average of 10% annually over the past decade. Their performance, as you'll see, is also quite remarkable.

Four of the five beat the market. One, Hershey, pulls nearly even with AMD. And a second, Illinois insurer RLI, blows by AMD and other tech heavies such as Microsoft and Cisco.

Get paid to own a multibagger
Few dividend payers will earn returns like RLI, of course. Its history is littered with acquisitions, restatements, and bumpy returns on equity (ROE). But a stable payer such as Hershey may not be so difficult to spot. According to Capital IQ, in 1996 Hershey had been increasing ROE steadily. And its 24.3% ROE that year was its highest since at least 1990, which is as far back as Capital IQ has data for the company. Its average multiple to normalized earnings was a little steep at 22, but that was down from 27 the year before and cheap compared to 31 in 1997.

Are stocks like the Hershey of 1996 available today? Sure. I ran a quick screen to find some. My search criteria included a minimum $5 billion market cap, a record of boosting dividends at least 10% annually more than five years, trailing-12-month ROE of 20% or better, and a price-to-earnings ratio of 17.5 or less, since that more or less equals the average earnings multiple of the S&P 500.

The screen returned 29 firms, including an energy firm that's walloped the market by more than 42% on the way to becoming one of the best-performing stocks in the Motley Fool Income Investor portfolio. That can't be too surprising to subscribers, though. Income Investor has ridden some of the world's best businesses to market-beating returns since its inception with an average dividend yield that exceeds 4%. (By the way, if that sounds enticing, ask us for an all-access pass to Income Investor. It's free for 30 days.)

The Foolish bottom line
I'll understand if your investing strategy is to nab as many multibaggers as you can. That's my strategy, too. Just realize that you don't have to find the next ultimate growth stock in order to double, triple, or quadruple your money. You can do that just by getting paid to invest. Call it the cheater's path to big returns.

Fool contributor Tim Beyers cheats the market as often as he can. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what is in his portfolio by checking Tim's Fool profile. Intel and Microsoft are Inside Value recommendations, and Merck is an Income Investor recommendation. The Motley Fool has an ironclad disclosure policy.