2 Stocks I'm in Love With

I'm in love with two stocks. Can you guess which ones?

With 10,000 or so publicly traded equities, that'd be tough without knowing a little bit more about me and what I look for in a stock.

My name is James Early, and I run the Motley Fool's Income Investor newsletter -- a service devoted to finding stocks that provide cold, hard cash to investors. I love dividend stocks because they pay out actual cash -- cash that can be saved, spent, or reinvested.

Reinvesting, in fact, is pretty powerful. How powerful? Had you put $1,000 into Philip Morris -- now Altria -- in 1980, you'd have nearly $70,000 now in principal gains.

But what if you'd reinvested the dividends along the way? You'd have a whopping $170,000!

Reinvest your dividends, or else
In other words, you want dividends, and you want to reinvest them if you can. Their power is mind-blowing. There's no better way to stock-market riches, Wharton professor Jeremy Siegel tells us.

I come from a hedge fund. It's where I learned to find undervalued stocks. But working night and day to beat the market taught me the value of an investing style that lets me sleep at night. And guess what? You don't need to stay up till 4 a.m. huddled over a spreadsheet to wallop the market: Income Investor is thumping the S&P 500 by 10 percentage points.

But beating the market is no walk in the park -- remember, there are more than 10,000 stocks to choose from. In providing two selections to subscribers every month, I set some parameters to better my odds. Here are two rules I'll share:

1. Watch out for companies that fund their dividend with debt: This isn't the kiss of death, but all else being equal, you want companies paying dividends out of cash they earn.

2. Swap free cash flow (FCF) for earnings when computing payout ratios: Many investors are surprised to learn that accounting "earnings" are only loosely connected with the amount of cash a business brings in, thanks to accounting rules that require businesses to spread out one-time inflows and outflows over multiple years. When you use FCF (earnings plus depreciation and minus capital expenditures), you may discover that a company's dividend is better covered than you thought. Or not.

One stock I love, hiding among seven
Let's put the rubber to the road. The following table shows seven stocks with dividend payments that are lower than net debt issued (debt averaged over three years to smooth out lumpiness), and with payout ratios below 90% on a FCF basis. They're starting points for further research -- and one of them is one of my two most recent Income Investor selections. Can you guess which one? Send me an email with "guess" in the subject line, and if you're right, I'll send you a free copy of my special report, The 21st Century's Most Precious Natural Resource, in which I peg a single stock poised to capitalize on a big change.

The other selection? Hey, I can't give the farm away. But thanks to a special guest pass, you can see it absolutely free -- and see if you guessed right (but no cheating -- email first!) -- by taking a one-month peek at Income Investor. Click right here to activate your guest pass.

James Early owns no stocks mentioned in this article. Coca-Cola is a Motley Fool Inside Value recommendation. The Motley Fool has a disclosure policy.