Stocks for Mad Money

Got a little mad money? Want to know where the really big returns are?

News flash: It's best to avoid the next hot glamour stock. Instead, consider a high-yielding dividend stock. Here's why:

1. Dividend stocks throw off actual cash -- and that reduces risk.
2. Dividend stocks tend to get less attention -- meaning great bargains are likely to stay on the table longer.

Imagine a stock with the power to turn $1,000 into $170,000. But unlike your typical mad-money stock -- up today, down tomorrow -- this stock's mind-blowing returns are built over time. Steadily. And with dividends.

That stock is Philip Morris, now Altria. And those returns I mentioned have been building since 1980, assuming reinvested dividends. Dividends are pretty powerful. And they give you an important option -- reinvest your dividends or take the dough. In Altria's case, if you were to tire of amassing monster wealth through the compounding power of dividend reinvestment, you could tap the cash -- to the tune of $7,000 per year. Those dividend checks will look pretty good in retirement!

Bottom line? The really big returns are in dividend stocks -- and generally over long periods of time. In fact, finding these long-term winners has helped the newsletter service I run beat the market by seven percentage points.

15% per year -- in cash
If you don't want to wait as your money compounds but still want a shot at big returns, dividend stocks can help. However, you'll have to look beyond your standard banks and utilities (though I'm a big fan of both for long-term portfolios). Some riskier stocks still throw off cash -- enough to support yields that range from high to flat-out skyscraping. There is some risk: Company finances could take a turn for the worse, taking a bite out of dividends and principal. But the potential gain is impressive -- 10% per year in pure cash is possible with some dividend stocks, not to mention the potential for capital gains.

You've waited long enough. Time for the stocks! To build this list of interesting stocks -- not outright recommendations -- I tossed in one stock with a 7%-plus yield. Then I used Capital IQ to screen for companies yielding more than 5%, sporting enterprise values greater than $500 million (for liquidity), and boasting three-year annual average dividend increases of at least 5% -- to zero in on companies that have demonstrated an ability to return more and more cash to shareholders. You want your dividends to grow, right?

Some of these stocks are indeed risky, but on the whole, this batch of high-yielders isn't as shaky as you might expect. They're likely on firmer footing than the next hot glamour stocks.

Foolish final thoughts
If you've got some mad money burning a hole in your pocket, do a double-take on some higher-yielding dividend stocks. And while you're looking, think about this: Many of the highest-returning stocks of the past 50 years were actually stodgy, well-run businesses -- that paid dividends.

I'm hunting for the best-returning stocks of the next half-century every day in Motley Fool Income Investor -- and I'm trying to bag a higher-risk dividend stock now and then, too. In fact, one of my favorites has an 8% yield -- a sustainable 8% yield. If you'd like to see it for free, I invite you to take a look at Income Investor. You have nothing to lose.

This article was first published Mar. 23, 2007. It has been updated.

James Early owns no shares of any company mentioned above. AllianceBernstein is a Motley Fool Income Investor recommendation. The Motley Fool has a disclosure policy.