Save Yourself From Massive Losses

By Tim Hanson | More Articles
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Together, eight years ago now, we watched the beginning of a downturn that cut the S&P 500 in half and dropped the Nasdaq nearly 80% off its highs. It was a maddening time for investors. Telecom and energy executives were caught with their hands in the corporate cookie jar. Technology shares plummeted, with hundreds of companies vanishing from sight. Very few bear markets in U.S. history have hurt so much. Silicon Image (Nasdaq: SIMG  ) fell from a split-adjusted $60 per share to $1. AndLTX Credence (Nasdaq: LTXC  ) traded from nearly $50 all the way down to $3.

Just how painful was it? Ask Nobel Prize-winning psychologist Daniel Kahneman, who proved that humans are innately loss-averse, particularly when it comes to money. Emotionally, losses hurt us far more than gains give us pleasure. Naturally, then, those massive declines crippled tens of thousands of investors, many of whom will -- sadly -- never throw the one-two punch of savings and investment again.

Fast forward to today and we're seeing the same cause and effect. The Wall Street Journal recently reported that many individual investors are just saying to heck with the stock market. That decision will have serious negative ramifications for their long-term savings, and even worse, it doesn't have to be that way.

Win with moderate risk
The solution is not to bail out of the market altogether, nor to seek shelter exclusively in bond funds. With the right perspective and useful tools, you can strengthen your stomach and beat the market -- because you'll do so without assuming huge risk. I know that's true because it's being done every year by the world's master investors -- from Buffett to Lynch to Tillinghast to Miller.

Those who take the biggest risks and buy what's hot today usually take the biggest hits in down markets. In the meantime, a host of methodical, smart, and contrarian investors ring up great returns, even through tough markets, by adhering to Warren Buffett's first rule of investing: Preserve capital.

Today, I want to focus on one sweet way to preserve capital and beat the market. The general principle is simple: Buy stocks that have paid uninterrupted dividends for years.

Consistency to victory
Let's investigate this idea by looking first at Procter & Gamble. P&G has paid a stable dividend since 1890. Yep, you read that correctly -- the company has paid dividends steadily for the past 118 years. Some of you may be thinking, "Bor-ing!" But over the past 15 years, through two bear markets, P&G has returned more than 13% annually, turning a $10,000 investment into $65,000 today. And when stocks like this temporarily decline, as they have recently, owners still get the dividend payment, inspiring all of us to be patient and calm -- two of the primary traits of the world's greatest investors.

Then there's BB&T (NYSE: BBT  ) , which has paid a dividend since 1903 and in the face of this significant economic crisis, actually increased its dividend in August. Like P&G, despite two bear markets, BB&T has returned a market beating 13% annually for the past 15 years.

This sort of investing success is happening every day in our Motley Fool Income Investor advisory service. Using a combination of outsized yields and capital gains, analysts James Early and Andy Cross are beating the market by six percentage points since the newsletter's 2003 inception.

But James and Andy aren't picking just any old high-yielders. They believe that to outperform the market, you have to find financially strong, well-managed, undervalued companies that pay dividends. Why take a chance on Joe's Next-Generation e-Hot Dog Stand -- with its jumpy beta, battered balance sheet, and 50/50 chance of going bankrupt -- when you could invest in a stable ship that returns profits to shareholders and provides capital returns over the long term?

It's a tried-and-true formula, and if you follow it, you'll save yourself from the market's volatility.

A monster income investment
Let's look at two of their top ideas. Income Investor recommended Tupperware (NYSE: TUP  ) in November 2005, when the famous food-storage brand was trading for $21. Using a discounted cash flow model, our team pegged its fair value closer to $25, later revising that valuation upward. Today, though the stock had once nearly doubled, it trades back at $21. Yet it remains a strong company that has rewarded investors with a market-beating 11% return thanks to its steady dividend.

More recently, the Income Investor team has been looking abroad to lock in non-dollar-denominated dividends. One of these picks is Philippines Long Distance Telephone (NYSE: PHI  ) , the dominant telecom in that country which is growing, undervalued, and offering a greater than 5% yield.

There are loads of great dividend-paying stocks, but they're not the market's most popular. In fact, you usually have to go digging to find them. But if you need a little help, you can see all our picks and research at Income Investor by clicking here for a free 30-day trial. There's no obligation to subscribe, and maybe -- just maybe -- we'll come through this crazy market without any massive losses.

This article was originally published as "Do You Have the Stomach to Beat the Market?" on June 10, 2005. It has been updated.

Tim Hanson does not own shares of any company mentioned in this article. BB&T is also an Income Investor recommendation. No Fool is too cool for disclosure.