Master investor John Neff, former head of the Vanguard Windsor Fund, beat the market by more than three percentage points per year for more than 30 years. In John Neff on Investing, Neff gives away his market-beating secret: Two of those three percentage points came from dividends. So while he worked hard to buy cheap stocks, yield was crucial to outsized total returns.
Beat the market at its own game
OK, so Neff looked for undervalued stocks with juicy yields. But how did he find them?
Actually, he gave away that secret as well -- he looked at the total return ratio. To find great opportunities, Neff sorted stocks by:
Total return ratio = (Analysts' expected earnings growth rate + Dividend yield)/Price-to-earnings ratio
And the higher the total return ratio, the better.
Yeah, right
I know what you're thinking. First, this is too simple. Second, because it's so simple, these opportunities must not exist today. Third, who cares about two lousy percentage points?
Well, then, in order: Yes, it is that simple. Yes, these opportunities exist today. And two percentage points might sound measly, but over 20 years, they'd add up to a heaping pile of cash. Consider: If you invested $10,000, after 20 years, 10% returns will give you $67,300. Add two percentage points on top, and 12% returns would give you $96,500 -- or 43% more.
Today's low-hanging fruit
According to data from Barra, the total return ratio for the market is about 0.8. So to emulate Neff, we want to look for opportunities that offer a total return ratio at least 50% greater, or 1.2. Here's what I found:
|
Company |
Growth |
Yield |
P/E |
Total Return Ratio |
|---|---|---|---|---|
|
Deutsche Telekom |
15% |
5.2% |
10.5 |
1.9 |
|
Nam
Tai Electronics |
20% |
6.9% |
18.5 |
1.5 |
|
Citigroup |
10% |
3.9% |
10.2 |
1.4 |
|
Taiwan
Semiconductor |
20% |
3.0% |
17.4 |
1.3 |
|
Cendant** |
13% |
2.5% |
12.1 |
1.3 |
|
Washington
Mutual |
10% |
4.5% |
12.3 |
1.2 |
|
Fidelity National Financial |
12% |
2.4% |
11.9 |
1.2 |
**Pending its spin-offs, management will not make any additional cash dividends for the remainder of 2006. The new individual companies will set their own dividend policies based on their capital requirements. Cendant states that the new yields will likely be lower than the previous aggregate yield.
The Foolish bottom line
Standing on the shoulders of giants like John Neff is one way to become a better investor and narrow down the number of stocks worthy of your research and time. It's a tack we take at Motley Fool Inside Value, and in fact, Cendant is one of analyst Philip Durell's current recommendations.
As Neff showed during his tenure, there can be a lot of long-term reward in buying cheap stocks that offer high potential returns. That's exactly the strategy we follow at Inside Value, and our recommendations are already four percentage points ahead of the market. If you'd like to learn more about Inside Value and try the service free for 30 days, click here.
Fool David Meier does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.
