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How To Generate High Income From Puny Yields

By Tom Dyson, publisher, The Palm Beach Letter
Tuesday, February 20, 2007

 

The newsletter I write, the 12% Letter, is dedicated to income generation. Stocks that pay big dividends are my bread and butter.

New Century Financial (NEW) is a good example of a high-dividend payer. In the last 12 months, it's paid out $7.30 per share in dividends, and you can buy the stock today for less than $20.

So assuming it pays out $7.30 again next year, you'll receive a 37% dividend.

Of course, next year's payout is hard to predict. On the one hand, NEW has paid bigger and bigger dividends every quarter, without fail, since it first paid a dividend in 2002. On the other hand, NEW is having serious business problems and likely will cut the dividend in 2007.

In other words, the high dividend yield is a signal that investors don't like this stock right now.

I haven't recommended NEW in my newsletter, and I won't. Most of my readers are retired. They need the income stream, but protection is also a major concern. Despite the meaty dividend yield, this situation is much too risky for them.


However, I recently recommended two stocks that I think really fit the bill... even if they do seem a little out of place among the other high-yield stocks in my portfolio.

These companies are the leaders of their industries and pillars of American capitalism... in other words, they are very safe. Just to make sure, I recommended them when their stock prices were depressed so even in the short-term, downside was unlikely.

But it's their income potential that I really like. If you buy one share in each of these companies... which right now will cost you almost exactly $100 for both... over the next 10 years, you'll almost certainly receive more than $75 in dividends... but with a pinch of luck, the payout could exceed $100.

In the year 2016, I project the one-year dividend payout could be as high as $15 from these two stocks combined... a 15% dividend yield on today's buy price of $100.

Here's the thing. Some of my readers didn't like these stock picks because – unlike NEW – they don't pay big dividends right now. In fact, their average dividend yield is a little more than 3%... so you'll probably only get $3 or $4 in dividends this year if you buy them today.

The difference is, the two stocks I picked generate their huge income streams through long-term dividend growth.

For example, stock A has increased its annual dividend 227% in the past 5 years... and 1,207% in the past 10 years. Stock B has increased its payout by 285% in the past 5 years and 567% in the past 10.

Stock A has a 41-year record of increasing its dividend every year, without fail. Stock B has a 31-year record.

As you can see, compounding dividend growth like this, over long stretches, soon becomes a huge source of revenue for the shareholder... that alone makes it a wonder why some people didn't like my picks. However, I haven't mentioned the best part yet...

As dividend payments get bigger, the stock price rises.

The two stocks I picked generally trade with an average dividend yield between 1.5% and 3%. Let's call it the market's normal range of sentiment for these two stocks. When the average reaches 1.5%, investors are optimistic about the prospects for these two companies and will pay a higher stock price for their dividends. When the dividend yield reaches 3%, investors are pessimistic, and the opposite is true. To be prudent, let's assume pessimism prevails.

If the dividend payout reaches $25 and average dividend yield is 3%, then your two shares of stock will be worth $500 dollars in 2016. ($15 divided by 3%).

Not only have you made 400% gains on your stocks, but they paid you $75 in dividends while you held them. And, you will continue to receive at least 15% dividend yields for as long as you keep holding...

And the whole time, dividend yields never rose above "puny."

Good investing,

Tom





Market Notes


WANT THE KIDS TO BE RICH? GET 'EM INTO THE MONEY GAME!

The invasion of Iraq four years ago has proved to be one of the great buy signals in asset price history. Nearly every measure of real estate, equity, and commodity prices sits near an all-time high.

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Some evidence: Goldman Sachs, up 100% in the past two years. Charles Schwab, up 84% in the past two years. Morgan Stanley, up 46% in the past two years.

And serving the self-starters of the world, INVESTools. Formed in 2001, INVESTools sells educational courses and seminars to the growing investor class. Revenue has doubled since 2003. Shares are up 250% in the past two years. Who knew selling financial information could be so profitable?



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