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 view 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 the recent economic conditions have decimated their stock prices over the past several months. Many companies unveiled big, multibillion-dollar buybacks plans, including a $3 billion repurchase authorization by Valero
By themselves, these announcements may give investors the impression that any company planning a buyback is a strong business with cheap shares. However, a recent study from Standard & Poor's doesn't back that up. According to the study, "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." Others have reconsidered their repurchase enthusiasm and suspended or scaled back their programs, as Wal-Mart recently did.
So repurchase plans alone don't signal impending outperformance. 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 were fronting millions to buy significant amounts of stock in 2007 -- stock that is now essentially worthless.
A better way
The key to earning superior returns lies not in timing the market, but rather in 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 these companies, which all combine an attractive yield and long-term return:
|
Company |
Annualized |
Current Yield |
|---|---|---|
|
Wells Fargo |
16%* |
8.8% |
|
Boeing |
9.8% |
3.9% |
|
JPMorgan Chase |
8.2% |
6.2% |
|
Merck |
13.4% |
5.5% |
|
DuPont |
7.8% |
7.1% |
Returns including spinoffs and dividends reinvested.
*Return from November 1984. Current yield subject to change.
James Early, advisor of Motley Fool Income Investor, regularly puts hundreds of high-yielding companies under the microscope, in search of the two he'll recommend each month. JPMorgan Chase has already made his 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. JPMorgan Chase is an Income Investor selection. Wal-Mart Stores is an Inside Value recommendation. The Fool's disclosure policy may be easy to overlook today, but in time, it will balloon larger than life itself.
