The 'Forgotten' Trait Behind Market-Beating Income Stocks
By Elliott Gue
June 19, 2013
Today, I want to share a little history lesson with you. It comes from one
of the worst periods of human history but makes a point about human
innovation that can't be said enough -- that given enough time and capital,
we're capable of some pretty remarkable things.
And the good news for investors like you and me is that we can use this
universal truth to profit handsomely...
The Great Famine was among the worst episodes of starvation in recorded
Crops were devastated after an abrupt change in weather patterns in the
early 1300s. Many seeds that were planted simply rotted in the soil.
Livestock couldn't be fed due to lack of grain, and malnourished stock
succumbed to disease.
Famine began to spread from poorer peasants to wealthier nobleman and
merchants. Even King Edward II had trouble finding food for himself.
Millions starved and died. By 1400, Britain's population stood at an
estimated 2 million people, off as much as two-thirds from its peak less
than a century earlier.
But over time, something happened that put an end to this: Farmers started innovating.
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A series of technological developments starting
around 1650 facilitated Britain's Agricultural Revolution. Regardless of
weather, farmers in England and elsewhere were able to use new technologies
to reap more crop yield than ever before.
As with any period of rapid technological change, the Agricultural
Revolution created vast wealth and fortunes for innovators such as John
Deere and others who ignored traditional farming practices
and replaced them with new methods.
The important lesson here for modern investors? Innovation in key industries
is at the heart of many of the world's most successful and best-performing
The concept is simple: companies that can build a better mousetrap stand to
make more money.
Developing and commercializing new technologies, in turn, requires spending
on research and development (R&D). Now, I know income investors don't
normally pay attention to a metric like R&D, but trust me, they should.
Of course, just because a company spends
billions on R&D doesn't mean it'll be successful in developing a profitable
and innovative new product. But there's still an established link between
R&D spending, innovation and stock market performance.
In 2006, a group of researchers led by Allan Eberhardt at Georgetown
University found that publicly-traded companies that quickly increase their
R&D spending outperform the broader market for at least 60 months after that
To test this concept, I examined the ratio of R&D spending to net sales for
S&P 500 companies over the past 20 years. I then ranked the top 25% R&D
spenders and put them in a portfolio.
Then I added one more important ingredient: Because I focus on solid companies
that pay dividends in my Top 10 Stocks advisory, I eliminated any stocks
with no earnings in the most recent quarter and any stock with a dividend
yield less than 1%.
My hypothesis: Companies with a history of returning capital to shareholders
via regular dividend payments are less likely to squander cash on expensive
and non-commercial R&D.
The results are impressive:
If you had invested $10,000 in 1993 in
profitable companies who spent heavily on R&D and paid a dividend,
you would have accumulated over $150,000 by the end of May 2013. By
comparison, the same $10,000 invested in the S&P 500 would have turned into
The connection between success and these key components
is clear. Innovative leaders with a history of consistent spending on R&D
and returning capital to shareholders have outperformed the broader
market by a roughly 3-to-1 ratio over the past 20 years.
If that doesn't convince you, consider one of my favorite picks -- Intel
It's long been a proponent of heavy R&D spending. In fact, the company spent
$10.1 billion on R&D last year, or more than Apple, Hewlett-Packard, and
Intel's technological dominance has allowed it to control 90% of the PC chip
market, and the heavy cash flow that comes with its success allows it to be
one of the most shareholder friendly companies on Earth.
Intel's stock has not only gained over 700% since 1994, it's also increased its
dividend by an incredible 6,441%. An investor who bought shares in 1994 would
see their effective yield grow from 0.4% to an eye-popping 28.7%
Simply put, cash-rich companies that make R&D research a priority and treat
shareholders to healthy and rising annual dividend payments make for some of
the best performing stocks.
All the best,
Top 10 Stocks
P.S. -- Dividend-paying, R&D-spending stocks like Intel are part of a special group of securities I call
"Forever" stocks. These are world-dominating companies that pay investors a fat dividend, dig a deep moat around their business to fend off competitors and buy back massive amounts of stock,
driving up value for the rest of the shares. And the longer you hold them, the more value they will give you every year. To learn more about these "Forever" stocks,
Six stocks out of 30 in the Dow had R&D budgets in 2012 that exceeded 10% of
sales. Here are the year-to-date returns of those six Dow stocks:
1. Microsoft (MSFT) -- 31%
2. Cisco (CSCO) -- 22%
3. Intel (INTC) -- 19%
4. Johnson & Johns. (JNJ) -- 19%
5. Merck -- 15%
6. Pfizer -- 13%
-- Investor's Business Daily