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 Beginning Principal
Year Ending Principal
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.
Price vs. 52-Week High
10-Year Compounded Dividend Change
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
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.