The Easiest Way to Double Your Returns

Like pro athletes, investors are always looking for that extra edge to juice their returns. Some turn to momentum trading or complex hedging schemes, while others put themselves in precarious margin positions.

In an effort to pick stocks on the upswing, investors often look at buybacks and insider buying as positive signals. The logic is noble: Put faith in those who have faith in themselves. But there's mounting evidence that these signals don't set investors up for any particular success.

The lure of the big buyback
Why have corporations been big on buybacks lately? For one thing, a few years of solid economic growth have left them flush with cash, even as many have watched their stock prices drop over the past year. And some big players plan on taking advantage of the recent turmoil -- Microsoft (Nasdaq: MSFT  ) announced another $40 billion authorization while Hewlett-Packard (NYSE: HPQ  ) wants to buy back another $8 billion of its stock. Even Nike (NYSE: NKE  ) tacked on another $5 billion to its plan.

These announcements tend to give investors the impression that the company is a strong business with cheap shares, but a recent study from Standard & Poor's does not back that up. It said, "While some S&P 500 companies have used buybacks judiciously, repurchasing at discounts to recent share prices, most companies have been too enthusiastic with their stock-buyback programs and have not increased shareholder value."

So repurchase plans by themselves don't signal that outperformance is on the way. The same goes for insider purchases, according to a recent paper from two German finance professors, who argued that "insider trades do not reveal exploitable information." As evidence, consider that numerous insiders at Thornburg Mortgage (NYSE: TMA  ) were buying significant amounts of stock in 2007 -- some at prices more than 200 times the shares' current split-adjusted value of $1.15 a stub.

A better way
The key to earning superior returns is not timing the market, but rather spending time in the market -- particularly if you hold great, dividend-paying companies over the long haul.

For example, let's say that an investor bought $10,000 worth of a stable, dividend-paying stock, then held it for 25 years. We'll assume 8% annual appreciation in shares, plus a constant 3.25% dividend yield paid at the end of each year. If you took those dividends each year and spent them, your 8% appreciation would still leave you with $68,485 after 25 years. Very nice.

But reinvesting that annual dividend could more than double those returns. With dividends reinvested in the example above, your total after a quarter-century would exceed $140,000.

The Foolish takeaway
Eager to turn this example into reality? There are plenty of fundamentally strong public companies paying consistent dividends that significantly boost returns over time. Consider a few that offer direct investment plans:

Company

Annualized
25-Year Return*

Current Yield

Pfizer (NYSE: PFE  )

12.7%

6.9%

Bristol-Myers Squibb (NYSE: BMY  )

9.4%

6%

Dow Chemical (NYSE: DOW  )

9.7%

4.9%

*Returns including spinoffs and dividends reinvested.

James Early and Andy Cross, our analysts at Motley Fool Income Investor, regularly put hundreds of high-yielding companies under their microscope and recommend two each month. Eli Lilly has already made their list of picks.

To learn more about all the selections, and how to double your returns through dividends, check out a no-obligation 30-day free trial.

This article was originally published on March 20, 2008. It has been updated.

Fool contributor Dave Mock still rejoices over change found in the sofa. He owns no shares of companies mentioned here. Pfizer and Dow Chemical are Motley Fool Income Investor selections. Pfizer and Microsoft are Inside Value recommendations. The Fool's disclosure policy may be easy to overlook today, but in time will balloon larger than life itself.


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