These are tough times for investors, and no one knows how bad it will get. But great investments are made from investing in the best businesses at the scariest times. Eventually this panic will end and business values will come shining through. In other words, we've certainly got the scary times -- now we just need to find the best businesses.
And I think I've found one. Before I reveal its name, say you're a typical investor, expecting 9%-10% nominal returns from the stock market based on historical results. Do you know where those stock market returns have come from?
Aside from a clever answer like long-haul winner Rohm & Haas (NYSE: ROH ) , you might have thought of earnings growth. As the economy has grown, stocks have earned more and more over time, and prices have adjusted upwards accordingly.
But amazingly, earnings growth has been responsible for only half of the market's return. The other half? Dividends.
Jack Bogle, the renowned index-fund guru and creator of the Vanguard index funds, says that dividends have accounted for five percentage points of the market's 9.5% average annual return over the past century.
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That's right, half the market's returns came from dividends. If you didn't own any dividend payers, the average return you could expect was only 4.5%, which, after inflation takes another three percentage points, leaves you with a 1.5% annualized real return before fees.
But a number of the big names don't pay any dividends -- for example, neither Dell (Nasdaq: DELL ) nor Sun Microsystems (Nasdaq: JAVA ) pays one. If you don't own any dividend payers, you could miss out on up to half of the market's future returns. In fact, the power of dividends is so strong that avoiding them actually handicaps your returns. It's like starting the 100-yard dash 50 yards behind the rest of the pack.
The perfect stock
But back to that perfect stock. By now you might be guessing where I'm going with this -- and you'd be right. My perfect stock pays a dividend, and a hefty one at that. Not only that, it has almost quadrupled its dividend payment over the past four years.
Although dividends are a key component of greatness, a dividend alone does not perfection make. The perfect stock would also have:
- Sustainable competitive advantages.
- Strong growth potential.
- Strong free cash flow generation.
- A valuation at a deep discount to its historical multiples.
So what is this perfect stock? None other than Pacific Airport Group, the owner of 50-year concessions to manage 12 airports in Mexico, including Guadalajara, Tijuana, Los Cabos, and Puerto Vallarta.
Because of the barriers to opening new airports, it operates as a virtual monopoly. It generates loads of free cash, and, because air travel correlates to GDP growth, long-term economic growth means long-term growth for the airline industry.
In other words, this is an investment for the long haul.
The bounce back is inevitable
It's currently trading at just more than $18 a share, down from a 52-week high of $50. This equates to eight times trailing earnings, compared with an average multiple over the past two years of 32 to 33. Stocks are pushed down for good reasons and for bad, so what's the story?
Mexican passenger traffic has slowed from double-digit growth last year to double-digit declines in recent months. Many of the low-cost airlines that were stimulating the market are experiencing difficulties with rising costs. And Pacific Airport Group's dividend is tied to its earnings, which could weaken if traffic worsens. Add in currency risk from the depreciating peso, and you can see why investors are scared.
This isn't a great time to be an airline -- even the more solid airlines like Continental (NYSE: CAL ) and Southwest (NYSE: LUV ) are struggling -- nor is it a great time to be an airport operator. But it is a great time to be an investor, and airports, unlike airlines, can make money in good times and bad. Plus, the airline industry is one of the most resilient in the market and has bounced back from every crisis since the time of the Wright brothers, just like it will bounce back from this latest bump in the camino.
Having all of those advantages and a cheap price makes it the perfect stock. And while investors are waiting for economic recovery, they'll still be earning a sizable yield. And that's why Pacific is at the top of my to-buy list, just waiting for me to gather the cash.
A good time to be an investor
There's a lot to like about dividend-paying stocks, not the least of which is their outperformance. They may have a reputation as stodgy slow growers, but we can point to many large dividend payers that have done well recently, including CARBO Ceramics (NYSE: CRR ) and Quality Systems (Nasdaq: QSII ) , which are up 4% and 20%, respectively, year to date even as the S&P 500 has fallen 38%.
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This article was originally published on Sept. 12, 2008. It has been updated.
Fool analyst Andrew Sullivan loves dividends and airports and owns shares of Quality Systems, but does not have a financial position in any other stocks mentioned in this article. Dell is an Inside Value recommendation. Quality Systems is a Stock Advisor selection. Pacific Airport Group is a Motley Fool Hidden Gems choice. The Motley Fool has a disclosure policy.