Shares of Apollo Investment (Nasdaq: AINV ) and Prospect Capital (Nasdaq: PSEC ) are down 20% and 7%, respectively, since July 10, 2008, yet I've made money on both stocks without shorting or using a sophisticated options strategy.
These aren't necessarily outliers. Using the same strategy -- the one I'll reveal in a minute -- you could have enjoyed 25% or better returns in each of these two "losing" stocks:
|N. European Oil Royalty Trust (NYSE: NRT )
|Resource Capital (NYSE: RSO )
Sources: Capital IQ, a division of Standard & Poor's, and Yahoo! Finance.
*From July 10, 2008, per Yahoo! Finance.
Our family portfolio has done almost as well. Our stake in Apollo Investment is up 18%, while Prospect Capital has returned 33%. Gross losses became net gains thanks to some not so fancy maneuvering on my part.
How did I do it? You know the answer.
Think about what these four stocks have in common and you'll realize how they became winners so quickly. Have the answer? That's right, it's dividends. But not just any dividend -- a high-yielding payout reinvested over the course of years.
And when I say big, I mean BIG. At 8.7%, Northern European Oil Royalty Trust's dividend is the lowest yielder among this group, while Resource Capital pays 15.2% as of this writing. Both Apollo Investment and Prospect Capital pay 10% or more -- more than four times the 2.25% offered by the average S&P 500 yielder.
2 dividend strategies, winners all around
By the end of this article, I'll have another 10% yielder that may be of interest to you. But I should first mention that you don't need huge yields in order to produce huge returns. Fool.com Managing Editor Brian Richards found that following a simple strategy of investing in dividend payers that increase their payouts by 10% annually for at least 10 years tend to produce market-beating results when held over time.
For those seeking market-crushing returns, high yielders also tend to be a good choice. A study by dividend expert and noted finance professor Jeremy Siegel found that over 45 years, the highest-yielding 20% of S&P 500 stocks outperformed the broader index by three times. More recently, Foolish colleague Dan Dzombak invested $10,000 of his own money on a portfolio of 10 high yielders and is reinvesting the proceeds. He's beating the market by more than 3 percentage points as of this writing.
The beauty of effective yield
I'm with Dan. I'm a huge believer in high-yield dividend reinvesting and have been since before Apollo Investment and Prospect Capital help lift our family portfolio out of the dark days of fall 2008. To me, their performance is a testament to the power of effective yield.
What's effective yield? When you reinvest dividends you buy more shares at the stock's price on the day the payout is made. Each new reinvestment brings more shares, and more shares means more dividends. Think of it like compounding interest. Or better yet, let me show you using my stake in Prospect Capital as an example:
Source: Personal portfolio records.
* Calculated based on 2008 run rate ($0.40 a quarter) and current run rate ($0.101 per month).
Two things should jump out at you in reading this table:
- Prospect Capital has cut its annual per-share payout by 24% since I began investing.
- My effective yield is 1 percentage point better than it was in 2008 and roughly 4 points better than what today's investors enjoy.
There is a catch, however. Fidelity lets me reinvest free of charge. Most brokers are equally generous, but some holdouts remain. Scottrade doesn't offer reinvesting, for example. (Get the skinny on what the best brokers offer in our Discount Broker Center.)
A great dividend payer worthy of further study
So reinvesting works and it's usually cheap. Now it's time to send you off with a high-yield idea worth exploring. The one I have in mind is one of two found by Capital IQ that:
- Trade on a major US exchange.
- Command more than $250 million in market value.
- Earn 7.5% or better returns on capital (double the risk-free rate).
- Have increased dividends per share by 10% or more over the past 7 years.
- Yield 10% or more as of this writing.
One of these stocks is Terra Nitrogen (NYSE: TNH ) , a 15.5%-yielding limited partnership that specializes in producing and distributing specialized fertilizer. The other is Telefonica (NYSE: TEF ) , Spain's leading telco and a stock recommended by my Foolish colleague Jordan DiPietro for his Rising Stars portfolio -- and one I'd recommend as well. Want details? Click here to read Jordan's latest thinking.
And when you're ready for more high-yield ideas, I recommend "13 High-Yielding Stocks to Buy Today." This free special report takes you under the hood of some of the market's top yielders and introduces you to a company one of our senior retail analysts calls "the dividend play of a lifetime." Get instant access to the name of this winner and 12 other top yielders by clicking here -- it's free.