Believe it or not, there is a philosophy of investing that will almost surely make you money in the stock market.
In fact, it has been practiced for hundreds of years, and up until very recently, was actually the method most used to invest in common stocks of companies.
The strategy has been lost in today's world of high speed trading, technical analysis, breathless CNBC talking heads, media-savvy hedge fund managers, and Twitter overload.
It is not the most glamorous way to invest, nor is it likely to make overnight millionaires. But it can earn very good (and increasing) returns year after year, at low risk. And using the Magic Formula® Investing (MFI) strategy can help you succeed with it.
How so? Let's get into it.
Investing for Cash Flow
In his outstanding book, Rich Dad, Poor Dad (really, just go read it now if you haven't), Robert Kiyosaki boils down success with money into a simple 2-step formula:
1) Have more cash coming in every month than is going out.
2) Use that excess cash to purchase cash producing assets.
Rinse, repeat... voila, financial success!
When rental real estate investors look at a property, they are not as concerned with the appreciation of the property as they are with the net cash flow from rents that it can produce. This cash flow is their monthly income, so it has to be substantially positive!
The same philosophy can be applied to stocks. Good dividend paying stocks put cash right into your account 4 times a year, REGARDLESS of what their stock price is doing. Companies with long track records of paying - and raising - their dividends provide you with a nice cash producing asset, and as long as those dividends are intact and you are not planning to sell it, the price of the common stock really does not matter!
Buy enough shares of good, dividend paying-and-raising stocks, and you could even find those cash payments adding up enough to meet - and then EXCEED - your monthly expenses. If you are shrewd and fortunate enough to reach that point, true financial freedom has been achieved and work becomes optional!
Of course, buying the right dividend-paying stocks at the right time is paramount. Buy a company that cannot sustain its dividend and then that share price matters a great deal.
And to accumulate enough shares of these dividend payers, and get a better payout on your investment, you must buy them when they are cheap. If you buy cheap enough, you can even get some capital gains to go along with those cash payments!
So how to find them? That's where the Magic Formula comes in!
Using the Magic Formula to Find Attractive Dividend Stocks
MFI is designed to find stocks of great companies (measured by return on capital) selling cheaply (measured by earnings yield). The best relative combinations are then highlighted by the screens.
So finding good dividend candidates is as simple as looking at the official screens (or the MagicDiligence screens) and finding the ones that pay dividends!
Well, almost! There are a few important steps to take to ensure that the dividend is both sustainable and is likely to be raised in the future. I won't go into too much detail in this article, but most importantly, make sure that the free cash flow payout ratio is at a reasonable rate, and that the company has a reliable record of dividend hikes in the past.
Just Give Me Some Stocks!
So, which current Magic stocks look like potentially attractive dividend opportunities? Here are some to consider:
The Tobacco Stocks
Altria (MO, Financial) (5.4% yield), Philip Morris (PM) (4.7% yield), Reynolds (RAI) (5.5% yield), and Lorillard (LO) (5.1% yield) are all current MFI stocks paying a 4.5% or higher yield, and all have a solid history of raising their dividend year after year. The waning social acceptance of cigarettes and ever-growing regulatory pressures have stopped any growth potential, but new and possibly less dangerous products like snus and electronic cigarettes (along with price hikes on traditional smokes) should help fill in the gaps. The only one in this group I don't like is Reynolds, as its payout ratio exceeds 100%. The others all have payout ratios of 75% or lower, with the lowest being Philip Morris at about 63%.
Kraft Foods (KFT, Financial)
When it comes to relative safety in business, few industries fit the bill better than consumer-based consumable products. In these industries, brand and scale are king. Tobacco products are one of these, as is Kraft's business of branded food and beverage products. Kraft's brands (Kraft, Oscar Meyer, Nabisco, Oreo, etc.) are ubiquitous on the grocery store aisles. Kraft currently pays a dividend yield of 3.8%, at a reasonable payout ratio of 76%. The company is run for income investors, with one of management's stated goals to raise the dividend by mid-single digit percentages (4-6%) annually.
Cisco (CSCO, Financial)
One of the true blue chippers of the tech world, networking hardware and software company Cisco has recently moved aggressively into the income investment bracket, instituting a dividend in 2011 and raising it over six-fold since then. With a current yield near 3.4%, a very safe payout ratio of just 32%, and a dominant market position in their industry, this is a fine cash flow investment. And with the stock trading at an enterprise value to earnings ratio of just 11, there is capital appreciation potential here, too.
