Introducing My Personal Formula for Wealth

Today, I unveil my personal formula for wealth. Climb aboard because shrewd investors have been profiting from this strategy for years, and today I'm sharing it with you. I will also reveal two stocks that can help you profit from this tactic immediately.

This is your time
First up, let's talk about timeframe and value-hunting. This is the most critical ingredient in my formula. I've talked in the past about the concept of time arbitrage -- buying from those with short timeframes and selling on our own terms, sometimes even decades later. I believe that is the best way to conceptualize classic Warren-Buffett-style investing -- which is buying great companies for less than they're worth and holding them as long as the fundamentals of the company are stable or improving.

When I see a company I like, beaten-down and plunging by 10% or more in a week, my first reaction is that "people must be selling it for a reason." But when I realize the majority of the sellers simply have shorter timeframes than me, I greedily dig into the company. If the fundamentals are sound, I become a buyer for the long term. You'll hear more about this concept a little later on when we discuss some specific stocks.

Success built on success
Next, let's discuss the magic of dividend reinvestment. This is relatively archaic next to a concept like time arbitrage, but it's just as important. This is especially true when you have to decide whether to pull out your dividend payments as profit or reinvest them in common stock.

As a simplified example, let's say you've invested $50,000 in a solid dividend paying stock like Southern Company, which is currently yielding 4.8%. Assuming the stock price and dividend payout stayed the same, you'd have roughly $2,400 in annual payments. If you stuffed that $2,400 under your mattress each year, you'd have a total of $98,000 after 20 years: your original $50,000 plus $48,000 in payments.

However, if you took that $2,400 and poured it back into Southern stock each year, here's what your returns and annual dividend payouts would look like:

Year

Year Beginning Principal

Dividend Payment

Year Ending Principal

1 $50,000 $2,400 $52,400
2 $52,400 $2,515 $54,915
3 $54,915 $2,636 $57,551
...      
18 $110,946 $5,325 $116,271
19 $116,271 $5,581 $121,852
20 $121,852 $5,849 $127,701

As you can see, the dividend is paid out on an increasing amount of principle each year. Here are the two methods compared against each other:

Unrivaled profit opportunity
Lastly, I look for companies (like the ones below) that consistently increase their dividends year after year. This is where the opportunity for unrivaled profits really comes into play for investors like us. As you know, companies don't set their dividend yield percentage; instead they set their dividend payout in dollars. Yield is then calculated by dividing that payout by the stock price.

By investing in a company that increases that payout every year, the yield on your original investment increases along with it. As an example, let's look at Nucor, which currently sports a yield of 3.8%. In December 2000, its yield was an unimpressive 1.6%, but if you had invested $50,000, your dividends would be more than $7,500 (an outstanding 15%!) in each of the past two years alone.

Certainly, Nucor investors have benefited from an appreciation in stock price over the same time period, but the fact that Nucor has increased its dividend by a compounded 25% annually is what gets me truly excited. As it continues to increase its dividend payment above the current $1.44, the original $50,000's yield will grow and grow.

A proven combination
Combine this with the two aforementioned elements (buying beaten down stocks and reinvesting dividends), and you have a market-beating formula for wealth.

Let's move out of the theoretical and into some actual stock picks you should consider for your personal portfolio. I started my research by scouring for the best dividend-paying stocks that are off their 52-week high and have a solid history of increasing their dividends. I then dug into my two favorites of the group.

Company

Price vs. 52-Week High

10-Year Compounded Dividend Change

Nucor (NYSE: NUE  ) 77.3% 25.8%
EOG Resources (NYSE: EOG  ) 79.7% 25.1%
Charles Schwab (NYSE: SCHW  ) 78.6% 19.9%
PPL Corporation (NYSE: PPL  ) 77.4% 10.3%

First, while EOG may have some dividend investors chuckling with their mere 0.6% yield, I like its long history of solid financial performance and its steadily increasing dividend.

Combine this with its strong position in the Eagle Ford play, in which it estimated 900 million barrels of oil equivalent potential, and the company becomes quite attractive. I like its already-entrenched position even more when I see reports like what Fool analyst Toby Shute filed on Tuesday stating that industry behemoth ConocoPhillips (NYSE: COP) is spending between $1 and $1.5 billion in Eagle Ford in 2011.

Next up, Nucor was my example in the graph earlier for its fantastic dividend history, and as I've mentioned in previous columns, I'm a long-term believer in the underlying company due to its mini-mill operating advantages when compared with competitors such as United States Steel (NYSE: X  ) .

Combine that with the fact that US Steel has a 10-year history of shrinking its dividend by a compounded 14% annually, and I know which is a better bet for my formula. I strongly believe there is a time arbitrage opportunity in the steel industry, which has been beaten mercilessly by the construction slowdown. Steel simply will be used when the U.S. economy picks back up. When it does, the strongest players like Nucor will be the ones to benefit the most.

The best of the best
While my digging uncovered some great potential candidates for the wealth formula, Nucor is the only one on my short-list for buying. The others will require deeper research, and I hope to provide that in this space as the opportunity arises.

In the meantime, I highly recommend scouring the web for more great dividend payers to work into your personal wealth formula. The absolute best place to start is a new free report assembled by Motley Fool analysts that highlights 13 high yielders, including the one stock Fool retail guru Jim Royal called the dividend play of a lifetime. I invite you to download it for free today. To get instant access to the names of these 13 high yielders, simply click here -- it's free.

Jeremy Phillips owns no companies mentioned in this article. Nucor and Charles Schwab are Motley Fool Stock Advisor recommendations. The Fool owns shares of Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (16) | Recommend This Article (90)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 02, 2010, at 2:22 PM, mkj1928 wrote:

    It's agood article. The question is this; Can you feel good about mgmt for a 20 year period? It's a good investing method but it gets tougher as global competition heats up.

    mkj

  • Report this Comment On December 02, 2010, at 4:06 PM, exdividendday wrote:

    How to build up wealth? So, there are so many ways to get rich. One way is to increase your savings and use them for investing. One way is to buy dividend growth stocks! I calculated different growth examples and showed how to increase your wealth in 20 years by the factor of 6.8 without reinvesting of your dividends. Here are my calculations:

    http://long-term-investments.blogspot.com/2010/08/how-growth...

  • Report this Comment On December 02, 2010, at 8:04 PM, jed71 wrote:

    I am a fan of this strategy. I already use a slight hybrid of this strategy in my portfolio. If you want to add a little additional income / cash flow to your holdings, try selling out of the money calls on high dividend payers that are financially stable. You can really turbo charge your portfolio by playing this strategy. I normally do this with slow moving stocks (have done it with MO for quite some time!). It's not a lot of extra income, but every bit helps. And when you are rolling it into additional stock over a long period of time (say, 10 year sas the article suggests), it adds up to be a handsome sum of extra dough. Good luck.

  • Report this Comment On December 03, 2010, at 12:14 AM, dbman5 wrote:

    Bah! A totally dumb idea. (said with tongue firmly implanted in cheek)

    I purchased a lowly utility stock in 1977 for $3000. Today it's paying me just over $4000 per year in dividends and the average return (dividends and appreciation) has been equal to investing that original $3000 at 11% compounded annually. Just before the big bust it was just over 13%.

  • Report this Comment On December 03, 2010, at 10:51 AM, Lockett03 wrote:

    Good to know my foundation for retirement is well known, the key is sticking to it and not getting greedy. Great article!

  • Report this Comment On December 03, 2010, at 10:58 AM, mpendragon wrote:

    Automatic dividend reinvestment has some downfalls. If you're a newer investor and don't have a lot in the market and you generally get your dividends quarterly then you could be in a position where the fee for buying new shares eat up a lot of your dividends.

    I like to pool my dividends over the year and add a new investment to improve diversification and help keep the fees in check.

  • Report this Comment On December 03, 2010, at 11:26 AM, Counterguy wrote:

    If you are with the right broker, then there are no fees for dividend reinvestment. I have my retirement accounts set up for dividend reinvestment and there are no fees attached and no commissions on the purchase. The broker gets their commission if and when I decide to sell the stock.

  • Report this Comment On December 03, 2010, at 11:32 AM, vriguy wrote:

    Good article, but you paint too rosy a picture. Taxes eat up a lot of your gains and you actually end up with a lot less than stated here. Of course, the tax effect applies whether or not you re-invest your dividends.

  • Report this Comment On December 03, 2010, at 2:24 PM, MattSEMO08 wrote:

    hello fellow fools i have a suggestion for a strategy it may be a good one or it may be a bad but any input is greatly appreciated but would it be a bad idea to buy 7 stocks that payout each mnth of the year buy another 7 that pay the other mnths and hold them and capture the dividend each month. for example ko, mcd, jnj, ul, kft pay one month and others pay other. any input is greatly appreciated for a beginner investor thanks for feedback

  • Report this Comment On December 03, 2010, at 2:45 PM, stan8331 wrote:

    It's true that the tax implications of dividends have to be considered for taxable accounts, but they have no effect at all on IRA's and other tax-free or tax-deferred retirement accounts. That's where they can be used to really juice long-term returns.

  • Report this Comment On December 03, 2010, at 7:33 PM, beadgrrl wrote:

    I think you mean "increasing amount of principal" rather than "increasing amount of principle".

    I doubt that the principles of your stock grow over time.

  • Report this Comment On December 04, 2010, at 11:36 PM, xetn wrote:

    First, get $50000.00.

  • Report this Comment On December 05, 2010, at 2:42 PM, busterbuddy wrote:

    It there were so many ways to get rich so many people would be rich. Who got rich the gold miners are the merchants selling them pants, food and clothing?

    But the key to this article is sound. And one items that people miss is that when there are financial crisis and stocks to down then your reinvested Dividends buy you more. Of course the argument is well but they cut the dividend. Well you don't buy those. And you say well who do you not buy. Well all financial crisis focus around the banks so I'd say for the last hundred years you have to be careful with banks. ATT and Southern company dropped but T increased its dividend during the crisis. So I'd say investing in T made sense.

    So unless the world ends, the phones still had work, Electricity still had to run, and Trucks and cars needed gasoline. And people still went to the drug stores. And women still used make up. And everyone still brushed their teeth. And most of us still used deodorant. So are you the rabbit or the tortoise.

    Invest first to supplement your income. Then invest for a rainy day. Then invest for retirement. If you think about it in these terms you will be successful.

    Unfortunate for my generation we used Credit Cards for a rainy day and to supplement our income.

  • Report this Comment On December 06, 2010, at 11:03 AM, mikecart1 wrote:

    Good article but it relies on perfection and ideal. Similar to F = MA. It doesn't account for the intangibles.

  • Report this Comment On December 10, 2010, at 4:38 PM, jobrfool wrote:

    Almost every discussion of return, dividends and otherwise, is cast in nominal dollars. It's hard to deal with inflation because there are so many ways to measure it, c.f.

    http://www.measuringworth.com/calculators/uscompare/

    I use 4% per year. Sounds tough, but if you aren't earning a real return after subtracting 4% annually, I claim you probably aren't getting any real return.

    I urge MF to focus on real return using whatever they think is reasonable.

  • Report this Comment On December 11, 2010, at 2:56 AM, Alijac wrote:

    One reader's comment I saw on a Finance Adviser's/Stockbroker's website declared:

    "I have a self-managed catastrafy".

    Due to my ever-being the embodiment of subtlety itself, and not wishing to offend the reader/commenter by spelling it out for them, lest I hurt their feelings, _ yeah... I know, I'm goin' straight to hell anyway so one more'll only expedite matters _ I wrote:

    "I had one of those too but the weal fell of it..!"

Add your comment.

DocumentId: 1387402, ~/Articles/ArticleHandler.aspx, 7/25/2014 9:50:52 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 34 minutes ago Sponsored by:
DOW 16,960.57 -123.23 -0.72%
S&P 500 1,978.34 -9.64 -0.48%
NASD 4,449.56 -22.54 -0.50%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

7/25/2014 4:00 PM
EOG $114.82 Down -1.38 -1.19%
EOG Resources, Inc… CAPS Rating: *****
NUE $51.33 Up +0.22 +0.43%
Nucor CAPS Rating: ****
PPL $33.43 Down -0.35 -1.04%
PPL Corp CAPS Rating: ****
SCHW $27.50 Down -0.29 -1.04%
Charles Schwab CAPS Rating: ***
X $27.72 Up +0.24 +0.87%
United States Stee… CAPS Rating: ***

Advertisement