Hunting for the Next Dividend Winner

I'm going to give you the names of two stocks, one of which could be the great dividend-paying stock in the years to come. And I am going to do that with knowledge that's available to everyone but that few act upon.

Buy like Graham; live like the Hiltons
When it comes to investing masters, only a few names readily come to mind: Buffett, Lynch, and my personal favorite, Benjamin Graham. These are the guys whose edicts and theorems have lasted through wars, shortages, corrections, bubbles, and scandals. And through all of these times, they have made mounds of money!

In his 1934 book, Security Analysis, Graham established five principles by which investors can not only beat the market but also pummel it. Since that time, investment houses that have incorporated his philosophies have done just this. And they have done so while watching competitors flail about chasing expensive stocks in cutthroat industries.

Stock-picking firepower
So what are these little principles of magic that can nearly guarantee success in the market?

  1. Companies with low prices in relation to asset value -- think Cisco Systems (Nasdaq: CSCO  ) with its nearly $20 billion in cash.
  2. Companies with low prices in relation to earnings, or ones that offer generous dividend yields and low prices in relation to cash flow. WashingtonMutual (NYSE: WM  ) is a decent example in the banking industry.
  3. Companies that display a systematic and significant pattern of insider purchasing.
  4. Companies that have recently experienced a significant decline in price -- Whole Foods Market's (Nasdaq: WFMI  ) 30% tumble since the end of October is a perfect example.
  5. Companies with small market capitalizations.

Taking home the trophy
When you match all of these qualities, you create a stock that presents a great value in terms of price, and you get a company that people in the know -- e.g., the insiders -- believe will succeed. When you can find this, studies have shown that you win.

When investment house Tweedy, Browne began to incorporate some of Graham's philosophies into studies it conducted, the results spoke for themselves. Time and time again, these factors together produced market-beating returns. To substantiate its findings, it also coupled its results with 44 other studies, half of which came from foreign markets. And the same story emerged. These principles work. And they work over the boundaries of time, country, and investing environment.

The five rules are special and don't always exist with one another, but that doesn't mean they never do. Often, they occur simultaneously as a kind of complement to one another. For example, a company that has had a bad earnings forecast and presents a low forward P/E often has also experienced a significant price decline.

Hitting the bull's-eye
For the purposes of my search, I limited the scope to companies that pay a dividend yield of greater than 2.5%, have experienced a considerable amount of buying from more than one insider, and experience significantly more insider buys than sells. I also have forgone the fourth principle -- a large decline in price -- because I believe good entry points into great stocks are never too far off.

So here are two stocks that just might take you for a good ride:

Company

Inside Buying
(Past Six Months)

Dividend Yield

Quintana Maritime Limited (Nasdaq: QMAR  )

12.3%

6.9%

Ark Restaurants (Nasdaq: ARKR  )

4.2%

4.1%

Data courtesy of Capital IQ, a division of Standard & Poor's.

Make it a habit
When you take an insider track that believes in the company, match it with a great dividend yield, and figure in some of the other important principles of Graham's Security Analysis, you find winners.

And these are exactly the type of companies that have bolstered the market-beating returns of the Income Investor newsletter. Take, for example, Income Investor's sighting of Norsk Hydro, which has returned 20% since its November 2006 recommendation alongside a healthy 2.5% dividend yield. Or take mover PPG (NYSE: PPG  ) , which has returned 20% since January 2006 and still carries a generous 3.0% yield.

We'd love to introduce you to an even more promising group of dividend payers and Graham-friendly superstars via our Income Investor service, which you can try for free for 30 days. The picks are soundly beating the market and recently offered an average current yield of more than 4.1%.

This article was originally published on Dec. 15, 2006. It has been updated.

Fool analyst Nick Kapur owns no shares of the companies mentioned above. Whole Foods is a Stock Advisor pick. Washington Mutual is an Income Investor pick. The Fool has a disclosure policy that is Graham-wellian in its effectiveness.


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