Beat the Market by 18%

Do you want to make some quick money? An easy buck with a hot stock?

Don't come to me.

My name is James Early, and in my Motley Fool Income Investor newsletter, I search out a steady, secure path to big-time wealth. Odds are, that's what you're looking for, too.

Spending all day (and sometimes night) hunting down the very best dividend stocks has given me a perspective on what to do -- and what not to do. I'd like to share some of what I've learned with you, and give you seven starting-point stock ideas based on a special screen.

Wealth Magnet No. 1: Own stock in companies that earn more in cash than they earn in non-cash "accounting" income.

In 1991, an Australian named Richard Sloan found results that at first he thought were too good to be true. So did academia: Only after five years of fighting was Sloan's paper published, and then in a somewhat off-topic journal. But his article, "Do Stock Prices Fully Reflect Information in Cash Flows and Accruals About Future Earnings?," contains arguably the most groundbreaking accounting finding of all time. Specifically, Sloan found that by buying conservative companies that take in more cash than they earn in "accounting" money, and short-selling firms doing the opposite, investors could do 18% better than the market on a yearly basis.

Think about it: A $100,000 investment compounding at 10% yearly becomes $673,000 after 20 years. Compounding at 28%, it becomes $14,000,000!

Wealth Magnet No. 2: Own dividend stocks.

The fabled Wizard of Wharton, professor Jeremy Siegel, uncovered a pretty potent statistic about the market's real return engine: From 1871 to 2003, only 3% of the market's total return came from capital gains on the original investment. The remaining 97% came from dividends -- specifically, reinvested dividends.

And these aren't the only studies that make the case for investing in dividend stocks with strong cash flows. I wouldn't be doing it for Income Investor unless I was confident I could make investors money.

Using an institutional data package called Capital IQ, I screened for stocks with market caps of more than $1 billion (the same threshold I use for uncovering Income Investor recommendations), higher cash from operations than net income for the past 12 months, and dividend yields greater than 2%. As a reminder, these simple screen results aren't formal recommendations like I'd make in Income Investor, but they're starting points for further research:

Company

Yield

Market Cap (in millions)

AT&T (NYSE: T  )

3.4%

$254,998

Home Depot (NYSE: HD  )

2.8%

$53,539

Chevron (NYSE: CVX  )

2.5%

$197,013

Johnson & Johnson (NYSE: JNJ  )

2.6%

$187,854

Verizon (NYSE: VZ  )

3.8%

$130,527

Wells Fargo (NYSE: WFC  )

3.3%

$111,972

PepsiCo (NYSE: PEP  )

2.1%

$114,772

Stay on the road to riches
There's a simple truth to investing: Staying away from the hottest stocks is half the battle. Much of the rest comes from aiming in the right direction to begin with -- that direction, I'll say, is cash-rich, dividend-paying stocks for many investors. Overwhelming academic evidence is on your side.

I research hundreds of dividend companies monthly to give my Income Investor subscribers the cream of the crop. In fact, a recent recommendation of mine has already clocked a 54% return in just a few months! It has ample cash flow, but it's not your typical Income Investor stock. Most are geared to follow a slower, steadier path to wealth.

To help you go the extra mile toward retirement, I'd like to invite you to take this free 30-day guest pass to my Income Investor newsletter. There's no cost to you (in fact, you could filch all 75-plus Income Investor recommendations free of charge, but I'm confident that you'll find so many winning stocks -- stocks perfect for you -- that you'll want to stay on longer).

Follow the cash
Academia tells us to seek out companies that earn lots of cash (you can check a company's cash flow on its aptly named "Statement of Cash Flows"), and that toss that cash back to shareholders after they've received it. Sure, cash-rich companies don't tend to be sexy, but the end game is all about returns in your portfolio, not glamour.

James Early owns no stocks mentioned in this article, although he now owns a Tyrolean hat, having just returned from the Italian Dolomites. Johnson & Johnson is a Motley Fool Income Investor recommendation, and Home Depot is an Inside Value selection. The Motley Fool has a disclosure policy.


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