The Stock Screaming "Buy Me!"

How much money could you make if you found out what really drives equity returns?

Ned Davis Research gave that question a closer look. It studied the period from 1972 to 2006, capturing the era of "fiat" money that followed the United States' departure from the gold standard. The researchers found that bifurcating stocks by one simple factor made an enormous difference.

That single factor: whether or not a stock pays a dividend.

Ned Davis found that from 1972 to 2006, S&P stocks not paying a dividend returned a measly 4.1% annualized. Dividend payers, meanwhile, returned a whopping 10.1% annually!

Keep reading for six dividend samurais
To put this power to work for you, I've got six stock ideas below, based on a special screen.

As a former hedge fund analyst, director of research and analysis for The Motley Fool, and now advisor for the Motley Fool Income Investor newsletter, I've seen a lot of academic studies in my day, and a six-percentage-point difference is absolutely enormous. It leads to a powerful, yet simple conclusion: If you're a stock investor, you'll profit by being in dividend stocks.

Finding just one great dividend stock -- the stock that should be screaming "Buy me!" to you -- can mean an early retirement, not to mention a wealthy one.

But how do you find that one stock?

How to make a fortune in the modern era
Let's consider an actual stock -- Mr. X -- whose identity will remain a secret for a moment. Mr. X isn't glamorous. He wouldn't seem to have a lot going for him. Most people don't even like his product. He's in constant litigation.

But Mr. X has a magic potion: compounding dividends.

If you had put $1,000 into this stock -- it's a real stock, remember -- in 1980, you would now have $47,000 in principal gains. That's nice. But if you had reinvested the dividends, you would have $213,000!

The thing is, Altria has likely had its day in the sun. It may well be a decent investment, but it's no longer screaming "Buy me!"

The challenge is finding the next Altria -- the next big dividend winner -- with returns so large you can buy the castle in Malibu instead of the condo in Cleveland come retirement (but only if you want to).

It's out there today, and it'll be screaming "Buy me!" to you -- if you're looking through the right investing glasses. Toward that end, I'd like to share two must-haves I've learned:

Must-have No. 1: Strong operational returns. The whole point of a business is to turn lead into gold -- to take capital and make it into even more capital. If return on equity, return on assets, and return on capital look anemic, investors' returns will likely be, too.
Must-have No. 2: A growing dividend. This signals more than just larger checks in the here-and-now. It signals a dividend-friendly board, which can mean the difference between a cash-monger and a cash-sharer as the years tick by.

There are pitfalls to watch out for in dividend investing. Don't lose your nest egg by falling through one of the trap doors below:

Trap door No. 1: The dividend double-take. I remember when my friend got stood up, left holding a dozen roses in a restaurant full of expectant onlookers. You might not have expectant onlookers -- though you may have a spouse -- but you don't want a company that bags out on its dividend. Look for a payout ratio of less than 80% for most companies. Math whizzes will want to replace net income with free cash flow in the formula, something I do in finding stocks for my newsletter, too.
Trap door No. 2: Closet debt. Return on equity (ROE) is great, and rightfully loved by investors ranging from your next-door neighbor to Warren Buffett. But companies know a dirty little trick: Load up on debt, and your ROE soars. That can be great, but don't take that check at face value. The company may have just gotten a lot riskier. Next time you see ROE spike, check if the debt has done the same.

The six dividend samurais
For some starting-point ideas (not formal recommendations, mind you), here are six stocks with ROE in excess of 10%, debt/capital ratios below 50%, free cash flow payout ratios of less than 80%, dividend yields greater than 1.5%, and payouts that have grown in the past year:

Stock

Yield

LTM ROE

Dividend Growth (YOY)

Debt/Capital

BP (NYSE:BP)

3.6%

25%

10%

45%

Coca-Cola (NYSE:KO)

2.5%

29%

10%

34%

Home Depot (NYSE:HD)

2.6%

19%

64%

31%

China Mobile (NYSE:CHL)

1.7%

23%

33%

10%

Procter & Gamble (NYSE:PG)

2.1%

16%

11%

34%

Southern Copper (NYSE:PCU)

5.8%

69%

35%

28%

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

The above stocks come from a statistically advantageous group, but I believe I've found some even better ones. Follow this special link, which gives you a month-long guest pass to my Motley Fool Income Investor newsletter, and you'll get my very latest -- and very best -- stock ideas for beating the market.

Here's my promise: Take a free guest pass, and you'll find at least one stock you love within the Income Investor service. With more than 70 ready-to-go dividend stock ideas, you'll probably find more than one. The service is beating the market by four percentage points since we opened for business.

James Early owns shares of Southern Copper. China Mobile is a Global Gains pick. Home Depot and Coca-Cola are Inside Value selections. The Motley Fool has a disclosure policy.


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Related Tickers

11/26/2014 4:02 PM
BP $41.59 Up +0.02 +0.00%
BP p.l.c. (ADR) CAPS Rating: ****
CHL $62.19 Up +0.22 +0.00%
China Mobile CAPS Rating: ****
HD $97.70 Up +0.69 +0.00%
Home Depot CAPS Rating: ****
KO $44.29 Up +0.17 +0.00%
Coca-Cola CAPS Rating: ****
PCU $31.38 Down +0.00 +0.00%
Southern Copper Co… CAPS Rating: ****
PG $88.88 Up +0.08 +0.00%
Procter & Gamble CAPS Rating: ****

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