These are tough times for investors and no one knows how bad it will get. But great investments are made from investing in the best businesses at the scariest times. Eventually this panic will end and business values will come shining through.
Well, we've certainly got the scary times, now we just need to find the best businesses.
And I think I've found one. Before I reveal its name, say you're a typical investor, expecting 9-10% nominal returns from the stock market based on historical results. Do you know where those stock market returns have come from?
Aside from a clever answer like Potash Corp.
But amazingly, earnings growth has been responsible for only half of the market's return. The other half? Dividends.
Jack Bogle, the renowned index fund guru and creator of the Vanguard index funds, says that dividends have accounted for 5 percentage points of the market's 9.5% average annual return over the past century.
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That's right, half the market's returns came from dividends. If you didn't own any dividend payers, the average return you could expect was only 4.5%, which, after inflation takes another 3 percentage points, leaves you with a 1.5% annualized real return before fees.
But a number of the big names don't pay any dividends -- for example, neither Yahoo
The perfect stock
But back to that perfect stock. By now you might be guessing where I'm going with this -- and you'd be right. My perfect stock pays a dividend, and a hefty one at that. Not only that, it's almost quadrupled its dividend payment over the past 4 years.
Although dividends are a key component of greatness, a dividend alone does not perfection make. The perfect stock would also have:
- Sustainable competitive advantages
- Strong growth potential
- Strong free cash flow generation
- A valuation at a deep discount to its historical multiples
So what is this perfect stock? None other than Pacific Airport Group, the owner of 50-year concessions to manage 12 airports in Mexico, including Guadalajara, Tijuana, Los Cabos, and Puerto Vallarta.
Due to the barriers to opening new airports, it operates as a virtual monopoly. It consistently throws off loads of free cash, and, because air travel correlates to GDP growth, long-term economic growth means long-term growth for the airline industry.
In other words, this is an investment for the long-haul.
The bounce back is inevitable
It's currently trading at $19 a share, down from a 52-week high of $58. This equates to 8x trailing earnings vs. the average multiple over the past two years of 32-33x. Stocks are pushed down for good reasons and for bad, so what's the story?
High fuel prices have significantly reduced demand for air travel this year. Mexican passenger traffic has slowed from double-digit growth last year to double-digit declines in August and September. Plus, many of the low-cost airlines that were stimulating the market are experiencing difficulties with rising costs. And PAC's dividend is tied to its earnings, which could weaken if traffic worsens.
This isn't a great time to be an airline -- just look at JetBlue
Having all of those advantages and a cheap price makes it the perfect stock. And while investors are waiting for economic recovery, they'll still be earning a sizeable yield. And that's why Pacific is at the top of my to-buy list, just waiting for me to gather the cash.
A good time to be an investor
There's a lot to like about dividend-paying stocks, not the least of which is their outperformance. They may have a reputation as stodgy slow growers, but we can point to many large dividend payers that have done well recently, including Norfolk Southern
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This article was originally published on Sept. 12, 2008. It has been updated.
Motley Fool analyst Andrew Sullivan loves dividends and airports but doesn't own any shares of the companies mentioned. Marsh & McLennan Companies is a Motley Fool Inside Value recommendation. Pacific Airport Group is a Hidden Gems choice. The Motley Fool has a disclosure policy.