How To Generate High Income From Puny Yields

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."