How You Can Play the 25% Cash Machine

When I started in the business as a broker with Smith Barney back in 1984, junk bonds and Michael Milken were just becoming all the rage in the high-yield market. At that time, for the most part, high-yield bonds were basically the entire high-yield market. Of course, the downside of these high-yield bonds was the massive amount of risk investors had to accept in order to get those big yields.

Along with the inherent risk of investing in low-rated corporate debts issues that were often used to finance leveraged buyout deals, a lot of chicanery and foul play came flooding into the high-yield market.

Well, we all know what happened to Mr. Milken and the firm Drexel Burnham Lambert. (For those who don't, the firm became entangled in an epic trading scandal.) That scandal tarnished the reputation of the high-yield debt securities market for some time, putting the kibosh on junk bonds for many income investors who rightly perceived this market as just too risky for their retirement dollars.

But today, income investors have opportunities in virtually every sector of the market. Indeed, the broad issuance of new income securities over the last decade has allowed income investors to have their cake (double-digit income) and eat it too (capital appreciation). And that's why I wrote The 25% Cash Machine.

The first objective of The 25% Cash Machine is to find the securities that can generate those double-digit yields we all need to fund our retirement years. The securities we choose must also posses the potential to grow by 15% or more per year.

Ten years ago, I would have said this was an impossible order. But now, thanks to the wide array of new income-oriented tools -- and a time-tested strategy that teaches you how to find the right securities -- I can say without equivocation that the goal of the 25% is definitely attainable.

First off, approach the market with an eye toward finding strong companies in strong market sectors. We are looking for superstar securities that throw off at least 10% annual yields while their underlying share price heads higher. Double-digit income investing isn't content with owning the likes of a Pfizer(PFE Quote - Cramer on PFE - Stock Picks), GM(GM Quote - Cramer on GM - Stock Picks) or any of the other dead-end dividend stocks. These stocks are antithetical to our goals, and they just don't meet our criteria for inclusion.

Another characteristic of double-digit investing is to look for securities that have what I call "yield power." These are securities that are currently in thriving businesses -- that is to say, they are in profitable ventures that make a lot of money. These securities pay out between 50% and 95% of their cash flow to you, the investor, in the form of dividends, interest or distributions. Determining yield power involves a basic calculation called a "payout ratio." This is just the percentage of every dollar of cash flow that gets paid out to shareholders.

Here's an easy example that will help illustrate: If a company has $2 of net income per share, and it pays out $1.50 of that $2, then we would say that it has a 75% payout ratio ($1.50 divided by $2.00 equals 0.75). This 75% payout ratio figure is a good one, because it tells you that a company is probably reinvesting some money into expanding operations and growing its business. And that growth and expansion helps us to identify the securities that, in addition to paying out double-digit returns, also have the best chance to appreciate by 15% annually.

The following is a list of some of the new tools we employ in The 25% Cash Machine to help us achieve our investment objectives:

Canadian royalty trusts: These securities have been in the sweet spot of the energy boom that began midway through this decade.

Closed-end funds: These funds pool capital and then invest in high-yielding bonds and other high-yield instruments that are not available to individuals.

Convertible securities: These are seldom used by individual investors; you can capture the same outsized yields that big institutional investors get with less risk and exposure.

Hybrid financials: They don't fit the mold of most conventional high-income vehicles, yet they are truly some of the best-performing equities, and they have generous yields.

Equity-linked securities: These are relatively new but very powerful investment tools for producing high yields with lower volatility and outstanding tax advantages.

Master limited partnerships: These babies are taxed only once at the corporate level, leaving plenty of cash to pay back in the form of dividends to its shareholders.

Preferred stocks: They are an ideal alternative higher-yielding investment than bonds in a deflationary environment.

These are all components of The 25% Cash Machine strategy. By putting these kinds of tools in your shed, and with the proper strategy to know how to operate these tools, you will never again have to settle for the 3%-5% yield you'll get from conventional income assets.