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Editor's note: Today, we continue our series from master business analyst Dan Ferris… Each day this week, Dan's sharing one of his "five financial clues" for finding great investments… the kinds of stocks that can make you a fortune with very little risk… the kinds of stocks you can pass on to your children or grandchildren. Read on to learn…

Whether You Invest $1,000 or $10 Million, Don't Ignore This

By Dan Ferris, editor, Extreme Value
Wednesday, September 25, 2013

Great businesses "pay back" their investors.
Yesterday, I showed you the first "clue" that indicates you've found a great investment: huge amounts of free cash flow.
The thing is, not all businesses use their cash to reward shareholders… to pay their shareholders back. But the great ones do. That's the second "clue."
Great companies reward their shareholders in two ways. The first strategy is pretty straightforward. But the second strategy… Most folks don't understand how it works.
Today, I'll cover both strategies. And I'll show you how the second strategy offers an enormous tax "loophole."
Let's get started…
The first way a great business rewards its shareholders is by paying cash dividends.
Cash dividends are usually paid quarterly, and they're good for two main reasons.
First, they provide you with a regular cash return on your investment. In fact, one study shows that investors earned 394% on stocks from 1991 to 2010, and that 43% of that return came from dividends.
Forty-three percent is a huge chunk of return. If you're investing in stocks, you simply can't afford to ignore dividends.
Really great dividend-paying companies raise their dividends every year for many years in a row, often for decades.
For example, Extreme Value readers have seen gains of more than 120% on Automatic Data Processing (ADP), which has raised its dividend every year for 37 years in a row.
In fact, with some good dividend-paying stocks, you'll make more on the dividends than you will by the share price going up.
Extreme Value readers have made more than 120% on Latin American Export Bank, for instance... with roughly 60% of that return coming from dividends.
What's interesting is, companies that begin paying dividends after not paying them often perform just as well as companies that raise their dividends.
A study by Ned Davis Research shows that stocks in the S&P 500 that either raised or initiated dividends from 1972 to 2004 outperformed all other stocks in the S&P 500.
The worst performers were companies that cut their dividends – or never paid them in the first place.
Bottom-line: Dividend-paying stocks are the best place to put a large chunk of your stock-market money.
Now... the second way companies reward shareholders is by buying back their own stock.
Why is this good for you? Well, when a company reduces its share count, it's like cutting a pie into four slices instead of eight slices. You're getting a much bigger piece of pie. Likewise, as the company's share count falls, each remaining share is worth more.
For example, tobacco giant Philip Morris (PM) is up 109% since I recommended it in Extreme Value in 2008. It has lowered its share count by 23% since then.
Constellation Brands (STZ), another Extreme Value stock, is up more than 170% since 2011. Its share count has fallen 12% since then.
And here's another reason why share buybacks are good...
You have to pay taxes on cash dividends... but you DON'T PAY TAXES when a company is using cash to buy back shares... even though a share repurchase makes your shares more valuable...
In other words, a share repurchase is like a tax-deferred, non-cash dividend that you receive for as long as you hold your shares.
So to sum up:
•   Look for companies that reward shareholders. Shareholders are rewarded in two ways: dividends and share buybacks.
•   Look for companies that raise their dividends every year.
•   Look for companies that buy back shares and reduce their share counts.

One more thing to keep in mind: Regardless of how much cash a business generates – or how much it rewards its shareholders – there's a major number you need to check before you know you've got a "sleep at night" investment. I'll share that with you tomorrow.
Good investing,
Dan Ferris

Further Reading:

The companies most likely to reward shareholders are companies Porter Stansberry calls "capital efficient." In short, Porter says, "If you want to become truly wealthy through investing... your best, safest choice is to buy these kinds of companies." Get all the details here.
Buying high-quality, capital-efficient companies and reinvesting the dividends is what Porter calls "the single greatest investment secret ever discovered." But most investors don't have enough patience or common sense to pursue this approach. Get "the best investment advice you'll never take" right here.

Market Notes


One of the market's few "left for dead" sectors is showing signs of life.
At the end of August, we told you to consider steel stocks. Despite the innovations in smartphones and computers, the world is still built on a foundation of steel, concrete, and other vital materials. Factories, cars, appliances, and bridges all require steel.
The steelmaking industry is one of the market's major "boom and bust" sectors. It enjoys huge upswings... and then crushing downswings. Get into the booms early, avoid the busts, and you can make great money trading steel.
Due to a sluggish global economy and excess production capacity, steel has been in "bust mode" for the past few years. Low prices have produced big losses for players like U.S. Steel (X). From early 2011 to mid-2013, the stock fell from $60 per share to $17 per share. But things are getting a little "less bad" for this beaten-down steel leader...
In just the last four weeks, shares are up 17%... and they've broken out to their highest price level in six months. This "left for dead" sector has a lot more room to run.

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