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How to Build a Portfolio that Returns 10% a Year for DecadesBy
Tuesday, August 31, 2010
I call them "junior" dividend raisers...
Regular readers will know that the safest, surest road to riches in the stock market is through compound returns.
To compound, you can use any investment that pays a return. All you have to do is reinvest the income you earn, and start earning income on your income. Even a bank account will compound your money, as long as it pays interest. To make the most out of compounding, you want the highest rate of return possible...
The rate of return makes a huge difference to the speed your wealth compounds. For example, $1,000 invested in a stock that returns 8% (dividends plus capital gains) for 50 years turns into $46,900. But $1,000 invested in a stock that returns 10% over 50 years turns into $117,400.
While you could use bank accounts or savings bonds to compound, I wouldn't recommend them, especially right now, with official interest rates set at zero. Instead, I recommend you use the stock market for your compounding strategy. There's simply no better place to find investments that generate high rates of return over long periods.
Today, I'm going to give you the best 220 stocks in America for generating compound returns. Using this list as your starting point, you'll have no problem building a compounding portfolio that returns 10% a year – and possibly much more – for decades to come.
As I showed you earlier this month, of all the income investments I've researched, the absolute best vehicles for generating compound returns are stocks that raise their dividends relentlessly year after year.
It takes a high-quality business to produce larger and larger dividends every year for many years at a stretch... So the stocks with the longest records of raising dividends tend to be household names like Coca-Cola, McDonald's, Johnson & Johnson, and Wal-Mart.
But as much as I love the way these companies raise their dividends and generate massive compound returns, I have a problem with these stocks...
I've never been more bearish on the stock market and the economy at large. These are the most prominent stocks in the world... While I doubt they'll fall as far as most other stocks when the bear returns, they're still going to shrink in value. I can't recommend them at current prices.
Instead, you should consider building your compounding portfolio with small-cap stocks or "junior" dividend raisers. By buying junior dividend raisers, you'll get several important benefits...
First, small-cap stocks solve the bear market problem. Big-cap dividend raisers like Johnson & Johnson make up indexes like the S&P 500 or the Dow Jones Industrial Average. When the averages fall, the large-cap stocks fall. Recent research in the Wall Street Journal shows that fluctuations in individual stocks and fluctuations in the averages have never been closer than they are right now.
In other words, the big stocks don't trade on individual merits anymore. They trade as the stock market trades.
Small-cap stocks, on the other hand, are not anchored to the overall market like large-cap stocks are. Sure, the market has an effect on their price, but mostly they trade on their individual merits, like revenue growth, profit, and dividend payments.
Secondly, small-cap stocks have more potential for growth. Growth should lead to faster dividend growth for us. A blue-chip stock might grow its dividend at 5% a year. The juniors in the list below grow their dividends – on average – 12% a year. (Not all small-cap stocks are growth stocks. But generally speaking, the smaller a stock, the more room it has to grow and pay us bigger dividends.)
Finally, the large pension funds, mutual funds, and insurance companies cannot buy small-cap stocks in any meaningful size. They're too small. So they ignore them. That makes them cheaper for us.
To help get you started on your research, I've prepared a list of junior dividend raisers. (Click here to see it.) First, I screened the market for stocks with market caps between $500 million and $5 billion. Then, I eliminated the stocks that haven't raised their dividends over the last five years. There are 220 stocks in this list.
For an approximate estimation of the long-term compound return you can expect from each stock, simply add the annual dividend growth rate to the current dividend yield. The current dividend yield is your cash return, plus the dividend growth will drive the stock price's growth.
The stocks in this list have an average dividend yield of 3% and an average dividend growth rate of 12%. That could mean as much as 15% annual returns. This is a rough estimation, of course. But you should have no problem building a portfolio from this list that compounds your money at 10% a year.
To maximize the performance of your portfolio in a bear market, I suggest you only choose the companies in this list with the lowest debt levels and the most "recession proof" business models. Choose around 10 companies and buy them in equal amounts. Tell your broker to reinvest the dividends and aim to hold your portfolio for a decade or more.
Harnessing compound returns is the surest way to build a fortune. Small-cap dividend raising stocks are the best investments for this strategy.
Good investing,
Tom
Further Reading:
A no-brainer compounding tip: Tom recently showed DailyWealth readers how to squeeze yields as highs as 40% from stocks that normally only pay 2%-3%. This little-known method grows your dividend automatically. As a bonus, it cuts out broker fees. Read more here: Turn an Ordinary Dividend Into a Double- or Triple-Digit Yield.
Market NotesA MEGA UPTREND IN SILVER One of DailyWealth's favorite ways to "go long" precious metals – one we've written about many times – is screaming right now.
While we believe you should hold the bulk of your precious metals in bullion, a few positions in precious metal stocks can add an incredible amount of "juice" to a conservative portfolio. One of our favorite ideas in this space is Silver Wheaton (SLW)...
As we profiled last October, Silver Wheaton isn't your typical "trucks and shovels" mining company. Silver Wheaton's business is based on financing mining projects and then collecting royalty streams from the ones that turn out to be big producers.
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