You can beat the market over time through "smart timing" and by investing in value stocks. And there is another way that may be even easier.

Indeed it is so easy it seems too good to be true.

New research has found that you could have beaten the market over many years simply by investing in the highest-quality, strongest, safest companies. 

Not only did they produce higher returns and lower risk, they actually did best in times of market turmoil. In other words, they offered you something close to a free insurance policy against meltdowns like 2008.

"Quality," observed Jeremy Grantham, legendary co-founder of Boston fund firm GMO, "has outperformed forever." GMO's own data, tracking "high quality" companies, finds that they have outperformed the Standard & Poor's 500-stock index by a cumulative 50% since 1965. Furthermore, he says, Standard & Poor's itself has tracked its own index of quality companies, the "High Grade Index," since 1925 and it has "handsomely outperformed" the rest of the market over the entire time--especially during periods such as the Great Depression.

High-quality stocks have produced superior returns with far lower risk, Grantham notes. They are, in other words, a "free lunch" for investors. (Grantham, "Playing With Fire," April 2010, at www.gmo.com. Registration required.)

"Quality" isn't the same as "value." Quality stocks are often more expensive in relation to their net assets or earnings than other stocks. "Quality" usually refers to companies that are highly profitable, which have strong balance sheets, stable earnings, respectable growth, and good cash flow. They have excellent credit ratings. They typically have very strong brands or patents or other "defensive moats" that allow them to fend off competitors without slashing prices. GMO's list of "high quality" U.S. companies include the blue-chip names you'd expect--such as old dependable like Chevron CVX) , Wal-Mart WMT) , Johnson & Johnson JNJ) , McDonald's MCD) , and Procter & Gamble PG) , along with newer tech names like Apple AAPL) , Google GOOG)and Microsoft MSFT) . 

Over time, a portfolio of high-quality names has beaten the market--even though the stocks have typically been more expensive than the overall market--and offered lower risk.

This finding was supported by research published recently by Cliff Asness and Andrea Frazzini at AQR Capital and Lasse Pederson of New York University. They looked at the performance of nearly 40,000 stocks in 24 countries, including the U.S., since 1951. They sorted out the "quality" companies using four measures--high profitability (measured by returns on assets), high earnings growth (measured by growth over the previous five years), safety (measured in terms of low stock volatility, low leverage, stable earnings, and high credit ratings), and payouts (measured as the percentage of earnings paid to investors as dividends or through share buybacks).

Their conclusions were threefold. The first was that high-quality stocks tended to trade at higher prices, in relation to assets and earnings, than lower-quality ones. In other words, the market had correctly identified higher-quality companies, and paid a premium for them. However, their second point was that the market didn't pay enough of a premium for these companies. Even though they were more expensive, their stocks still outperformed the market over time because they did even better than the optimistic market had expected. And, thirdly, they found that quality persisted--that high-quality companies tended, in the main, to stay high quality.

Over time, says NYU's Pederson, "quality" tended to beat the overall market by about three percentage points a year, with substantially lower volatility. That is a huge gain over time.

What this means is that you could have beaten the market simply by putting together a broad portfolio of top-quality companies and then pretty much leaving them alone, with minimal interference. Furthermore, such stocks tended to do best at times of stress--so not only did you not have to worry about them, you could probably have owned more of them, and fewer bonds, because they would have fallen by much less in times of crisis.

Five Dangerous Dividend Yields Above 10%

November 11, 2013 by Jon C. Ogg

Source: Thinkstock

Investors have been told over and over to love dividends, as they provide income and stability to a portfolio. While those themes are often true, there can be a dark side to dividend investing. A number of companies have unbelievably high dividend yields. It is often questionable whether these companies can maintain such high yields.

Investors like dividends for more than just the periodic income they provide. A strong dividend generally signals that a company is especially stable, and it is supposed to reflect its expected earnings power in the future.

The highest dividend yield in the Dow Jones Industrial Average is about 5%. When a company’s dividend yield is more than twice that, investors may be taking on serious risk. That is because there are two ways for yields to climb so high — either the company can increase the dividend payment or the company’s share price may have taken a hit. While we always hope for the former, a very high dividend yield often implies the latter. Having a dividend yield north of 10% is far higher than what investors can earn on most junk bonds.

24/7 Wall St. searched for companies with dividend yields of at least 10%. Some are pure dividends, some are considered dividend equivalent yields because they include a return on capital.

Most of the five companies with potentially dangerous, high dividend yields are in sectors that typically provide investors with high payouts. These include the mortgage real estate investment trusts (REITs), master limited partnerships (MLPs) and business development companies.

1. Annaly Capital Management
> Dividend yield: 13.2%
> Annualized dividend: $1.40
> Share price: $10.64
> Industry: REIT

Annaly Capital Management Inc. (NYSE: NLY) is a mortgage real estate investment trust. The company operates in an often volatile sector. In addition, issues related to the Federal Reserve’s purchases of mortgage backed securities under its quantitative easing plan pose challenges for all mortgage REITs. Annaly’s shares lost some ground after the company recently reported very weak third-quarter earnings. Currently, shares are trading around their 52-week lows, at $10.64. Annaly has been cutting its dividend payments since 2010, and some analysts expect that to continue. The consensus analyst price target is $12.35.

2. Chesapeake Granite Wash Trust
> Dividend yield: 20.6%
> Annualized distribution: $2.67
> Share price: $12.97
> Industry: Oil and gas

Chesapeake Granite Wash Trust (NYSE: CHKR) is another company that seems a bit scary on the surface because of its high distribution. Its market cap is less than $600 million, and it has only been public since late 2011. Although investors may be attracted by the high distribution yield, the trust carries of more than 22%, its shares may also carry a great deal of risk. In fact, the trust recently hit a 52-week low and is down roughly 40% from a 52-week high of $20.25. Goldman Sachs recently downgraded the trust to Sell from an already cautious Neutral rating, based on expectations that distributions would decline.

3. Prospect Capital
> Dividend yield: 11.8%
> Annualized dividend: $1.33
> Share price: $11.26
> Industry: Asset management

Prospect Capital Corp. (NASDAQ: PSEC) is a business development company. It is involved in all aspects of financing for middle market companies, providing both private debt and equity, including refinancing, leveraged buyouts and acquisitions. It is one of the larger companies in its sector, with a $3.2 billion market cap. Prospect Capital pays dividends monthly rather than quarterly, and its dividend yield is 11.8%. Its shares are currently trading at $11.26, against a 52-week trading range of $9.80 to $11.62. The consensus analyst price target is $11.95.

4. QR Energy
> Dividend yield: 11.6%
> Annualized distribution: $1.95
> Share price: $16.88
> Industry: Oil and gas

QR Energy L.P. (NYSE: QRE), which has a distribution rate of 11.6%, is one of the larger master limited partnerships. But it is worth noting that MLP distributions generally are part income and part return on capital. Its distribution has been stable, and its share price of $16.88 is roughly in the middle of its 52-week range of $14.76 to $18.75. Since QR Energy went public late in 2010, its units have underperformed industry leaders. QR Energy’s consensus analyst price target is $20.29.

5. Windstream Holdings
> Dividend yield: 12.5%
> Annualized dividend: $1.00
> Share price: $7.98
> Industry: Telecom

Windstream Holdings Inc. (NYSE: WIN) is a communications and cloud services provider for businesses. The company set its annual dividend at $1.00 before the recession and has managed to maintain it since. This has surprised investors, especially recently, as the payout has become much higher than the company’s 2013 and 2014 earnings estimates. Windstream is the only company in the S&P 500 Index with a dividend yield north of 10%. The company is highly leveraged, even with a market cap of close to $5 billion. The company’s shares sold off after the latest earnings report. This may be a sign of investor concern, even if the company has maintained that its dividend policy has not changed. Windstream’s consensus analyst price target is $9.13.