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Wednesday, June 19, 2013 - 11:30
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Wednesday, June 19, 2013 - 11:30

This 'Rich Parent' Stock Has Beaten The S&P 5-to-1

Wednesday, June 19, 2013 11:30 AM

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 history.

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.

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 companies.

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 increase.

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 just $53,700.

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 (Nasdaq: INTC).

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 SAP, combined.

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 dividend yield grow from 0.4% to an eye-popping 28.7% today.

Action to Take --> 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.

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, click here

Elliott Gue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of INTC in one or more of its “real money” portfolios.