If you've followed my past articles, then you already know that I invest exclusively in the world's greatest businesses -- the kind that dominate their markets and typically go out of their way to reward their shareholders via dividends and share buybacks.
In fact, as you'll see in a moment, one of my favorite companies just doubled its dividend
Sadly, many investors don't put their money in stocks like this. Instead, millions of small investors end up pouring money into risky securities that I think are likely to lose them money. They think they need to invest in volatile, unproven companies in order to get rich. They want to "go where the action is."
Don't believe me? Consider what's going on right now.
You've no doubt heard the news about recent multi-billion-dollar Internet IPOs. "Web 2.0" companies such as Groupon, Zynga, LinkedIn and Facebook are the darlings of Wall Street
right now. The mainstream financial press can't get enough of them. For example, Facebook has dominated the headlines for months, despite the fact that it hasn't even gone public yet.
Meanwhile, investors are blindly throwing money at these companies. Zynga (Nasdaq: ZNGA)
, which makes online video games, is up about 35% since going public
. But the company doesn't turn a profit
. Far from it. Zynga has lost $400 million during the past year. The firm's net loss
came out to $1.40 per share... or about 10% of its current share price.
LinkedIn (Nasdaq: LNKD)
, a social networking site for professionals, is up slightly since going public. But it's been a wild ride. The stock trades at a price to earnings
(P/E) ratio of almost 800.
Groupon (Nasdaq: GRPN)
doesn't even have a P/E ratio... because it has no earnings. In the past year the company has lost $350 million, or $0.97 per share.
Facebook -- considered to be the "hottest" of all these companies -- hasn't gone public yet. At this point, we can only guess what sort of enormous valuation it might see. Estimates are calling for a valuation of $100 billion. With net income
of $1 billion in 2011, that means the stock could sell for 100 times earnings.
And not only do these stocks trade at ludicrous valuations, but they are tremendously volatile. Zynga dropped -18% in a single day after announcing earnings in February. Groupon dropped -14% after announcing disappointing earnings just a few days earlier.
Yet, some people still think these companies are attractive investments.
This strategy is suicidal. It just doesn't work for most small investors. And in the process, I'm convinced that the overwhelming majority of investors lose a ton of money in the stock market
Look through your own investing history or start asking your friends and family members. Ask them about the worst stock investment they've ever made. I'm almost certain it will be an unproven stock that seemingly had big "potential." It likely didn't pay a cent in dividends... or buy back stock... or even trade at a low valuation.
I say "no thanks" to these types of risky investments. I've been investing actively for two decades, and during that time I've learned a lot of valuable lessons. The single most important one is this...
The best way to become wealthy in the stock market is by owning companies that dominate their markets, are essential to our way of life, and that continually reward their shareholders with cash.
Nothing is guaranteed, but I've found that the most consistent returns come from these types of companies.
Take MasterCard (NYSE: MA)
, which I named as one of my "Forever" stocks.
Is MasterCard a dominant company? Absolutely.
Worldwide, this company boasts 930 million customers... it has its hands in more than $2.7 trillion of commerce
... and has more than 1 billion of its cards in use.
It essentially operates in a duopoly
with Visa (NYSE: V)
. Together, these two companies control about 80% of the U.S. credit card
market. And MasterCard receives a fee each time a card is swiped on its network.
More than anything, the company acts as a tollbooth.
As you would expect, that makes the financials look unbelievably good. The company holds nearly $40 per share in cash (about 10% of the share price). It has zero debt. It is buying back $1 billion of its stock, and has annual revenue of $989,000 per employee, according to Bloomberg.
And just last month MasterCard announced it was doubling its dividend to $0.30 each quarter. Right now the yield
isn't anything to get excited about -- it's less than 1%. However, with the cash MasterCard is generating, I believe that dividend will continue to grow in the years ahead, making the stock a great "dividend-growth" investment.
More importantly, the stock's performance proves that investing in dominant companies like MasterCard is the right thing to do.
When I tabbed the stock as a "Forever" holding back in July, shares
traded at $304. By Thursday, they had steadily risen to $420 -- a gain of nearly 40%. The S&P is up 6% during that time. (Following the rally in MasterCard, I'd suggest new investors wait for a pullback below $400 before buying the stock.)
To me, that's just more proof that stocks like MasterCard are how you become wealthy in the stock market. In fact, since identifying my 10 "Forever" stocks less than a year ago, there have already been five dividend increases among the group, and the average return is 17.1% -- nearly triple the S&P. (You can visit this link to learn more about these 10 "Forever" stocks
Action to Take --> If you want to keep investing "where the action is," there's nothing to stop you. But if you're investing in stocks trading at 800 times earnings that pay no dividends, like LinkedIn, then I think you're not investing... you're gambling.
And gambling is not how you become wealthy in the stock market.
Paul Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of MA in one or more if its “real money” portfolios.