Analysts Say This Stock Is a Double

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Pssst. I've got a stock tip for you. The following companies have been savaged over the past several years and, hey, analysts say each of them is at least a double.

Curious? Well, here you go.

Company	Recent Share Price	Analysts' Average Price Target	Potential Upside
AIG	$23.45	$49.40	111%
UAL	$5.67	$16.00	182%

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

Great, right? There's just one glaring problem.

I wouldn't recommend these stocks to my worst enemy
You heard me. Look, if you're looking to cash in here, you may as well skip the "stocks" part and just buy some scratch-off lottery tickets. At least that way, you'll support local schools while you vaporize your remaining savings.

For starters, consider that Wall Street analysts are notoriously inaccurate. The analysts are sheep, dragging their estimates and targets behind the market like a puppy chasing after its owner.

Now, to me, there are some very good reasons why these companies have been hit so hard. Even before you get into AIG's horrid results and the question of what other dragons lurk on its balance sheet, calculating a fair value for AIG is next to impossible, given the epic shareholder dilution we'll see. And as for UAL, I'll believe that United or nearly any other airline (save Southwest Airlines) can achieve consistent profitability just as soon as pigs fly.

OK, so these stocks are, at best, value traps. Now what? Well, if you're ready to make the leap from a speculator to an investor, read on.

The path to huge returns
Building real wealth doesn't happen overnight, and it certainly doesn't happen by making emotional short-term bets on bad companies. Consider the following:

• A study published in The Journal of Finance showed that investors who trade most frequently trail the market by 6.5 percentage points annually.
• According to Wharton's Dr. Jeremy Siegel, portfolios of the highest-yielding stocks returned 4.8 percentage points higher annually, with less risk than baskets of the lowest-yielding stocks, over the years 1958 to 2002.
• The list of top-performing surviving S&P 500 members from 1957 to 2003 is dominated by dividend payers, names like PepsiCo (NYSE: PEP), Merck (NYSE: MRK), Bristol-Myers Squibb (NYSE: BMY), General Mills (NYSE: GIS), and Philip Morris, which was the former combined package of Altria (NYSE: MO) and Philip Morris International (NYSE: PM).

In short, the path to building wealth and crushing the market over the long haul doesn't involve day trading or chasing after the next rocket stock. It just requires patiently investing in the tried and true -- specifically, blue chips that pay large, sustainable dividends.

Getting paid to invest
The merits of dividend-focused investing are fairly obvious: The strategy is a proven market-beater over the long run, it comes with lower risk, and you get paid cash along the way. For perspective, the average yield of the companies recommended by our dividend-focused newsletter, Income Investor, is 4.8%. Compare that to the flat 2.8% yield you can get on a five-year CD.

Of course, you can't just throw darts at a dividend dartboard and hope for the best. You'll want to take a page from our Income Investor playbook. We seek to separate the wheat from the chaff, by specifically looking for:

1. Dividend yields greater than 3%. Again, research shows that stocks yielding above-market rates provide higher returns with lower risk.
2. Capital gain potential. What can I say? We're a bit greedy. We only recommend companies trading at big discounts to their intrinsic value.
3. Great management, great returns. We like tenured management teams that have brought home the bacon via long histories of dividend increases and double-digit returns on invested capital.
4. Durable competitive advantages. Companies with big moats: unique, sustainable cost advantages; network effects; valuable intellectual property; high switching costs; and so on.

There aren't many companies that make the cut. At best, we think the universe of stocks capable of making the Income Investor grade is only a couple of hundred companies, among the thousands of publicly traded names out there.

How about a case in point? Take Automatic Data Processing (Nasdaq: ADP), which I recently recommended to Income Investor members. The payroll processing kingpin is AAA-rated and consistently rakes in mountains of cash thanks to the clockwork-like fees it charges clients and the fat interest income it earns on its float. Despite that and its annual price increases, though, clients can't get enough of ADP: ADP's average client retention is more than 10 years in its core payroll business.

The shares yield a rock-solid 3.4% right now, and that payout should grow at a healthy clip over the next several years. An overnight double? No. An outstanding, low-risk business trading at a great price? Yes, sir.

Buy great companies.
Buy them cheaply. Hold them. Reinvest your dividends. I'd be lying if I said this was rocket science. Again, though, few companies are even in the range of consideration for the Income Investor cut. In fact, even our beloved ADP hasn't yet cracked our elite top-6 "Buy First" list. To find out which stocks have, and to receive our top new stock idea each month, you can try the service free for 30 days -- just click here to learn more.

This article was originally published on May 5, 2009. It has been updated.

Senior analyst Joe Magyer owns shares of Philip Morris International, PepsiCo, and Automatic Data Processing. PepsiCo and Automatic Data Processing are Income Investor recommendations, while Philip Morris International is a Global Gains recommendation. The Motley Fool has a disclosure policy.