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With low interest rates in the bond market, many investors are embracing credit risk in the junk bond market or taking on interest rate risk with long-duration bonds.

Instead, Joel Greenblatt's Magic Formula can be re-purposed to find attractive stocks that pay dividends. In a prior article, we showed that it could be restricted to picking dividend-paying stocks without detracting from the performance of the Magic Formula. Encouraged by this success, we used this screening method to create a current list of the best dividend stocks to buy in today.

This strategy is designed for income investors who are concerned that dividend-yielding stocks are becoming too pricey. It combines a screen for dividend income with Greenblatt's screen for the best stocks trading at the cheapest values.

What is the Magic Formula?

Joel Greenblatt reported enviable annual 30.8% returns for his "Magic Formula" in his book, "The Little Book that Beats the Market". Since publishing his book, his strategy has performed well. Though many analysts who have followed the "Magic Formula" have not seen 30.8% annual returns, they typically report outperformance from this strategy. His results are particularly interesting because his picks are not subjective: they are based on a simple ranking of earnings yield (EBIT/EV) and return on capital.

Even more interesting, Magic Formula stocks have historically outperformed the market with a total portfolio which is a blend of value and growth with a beta of roughly one. This blended profile of Magic Formula picks lends itself to do-it-yourself investors as a core holding strategy. Moreover, since many of these picks have dividend yields, they can be used to create an income portfolio.

Screening for Magic Formula Dividend Stocks

The following methods were used to extract appropriate dividend-yielding stocks from Greenblatt's Magic Formula results:

Stocks were selected using the Magic Formula methodology. Each of these stocks is one of a top-50 selection with a $50 million, $2 billion, or $10 billion market capitalization minimums.

Stocks were screened for dividend yield. Of these Magic Formula picks, stocks with no dividend yield or which had a dividend yield less than the 10-year Treasury were removed.

Stocks were screened for payout ratio. Only stocks with payout ratios under 60% were retained. Dividend payouts under 60% are considered reasonable and sustainable.

These firms hail from many different industries and have an average dividend yield that is about twice the 10-year treasury yield:

Ticker

Company

Industry

Dividend Yield

Payout Ratio

AAPL

Apple

Personal Computers

2.35%

12.0%

ACN

Accenture

Information Technology Services

2.17%

36.5%

ADP

Automatic Data Processing

Business Software & Services

2.85%

57.6%

AMGN

Amgen

Biotechnology

2.17%

25.5%

BA

Boeing

Aerospace/Defense Products & Services

2.53%

35.0%

BLC

Belo

Broadcasting - TV

3.68%

37.4%

CA

CA Technologies

Application Software

4.07%

51.0%

CAT

Caterpillar

Conglomerates

2.27%

23.2%

CL

Colgate-Palmolive

Personal Products

2.18%

46.8%

COH

Coach

Textile - Apparel Footwear & Accessories

2.56%

30.5%

CSCO

Cisco Systems

Networking & Communication Devices

2.68%

25.1%

DELL

Dell

Personal Computers

2.30%

5.3%

DGX

Quest Diagnostics

Medical Laboratories & Research

2.15%

17.2%

EBIX

Ebix

Business Software & Services

2.17%

9.6%

EMR

Emerson Electric

Industrial Equipment & Components

2.86%

57.2%

FCX

Freeport-McMoRan Copper & Gold

Copper

3.85%

39.0%

GIS

General Mills

Processed & Packaged Goods

2.89%

46.2%

HLF

Herbalife

Drug Related Products

3.26%

27.1%

HON

Honeywell International

Diversified Machinery

2.35%

40.8%

INTC

Intel

Semiconductor - Broad Line

4.41%

39.5%

ITW

Illinois Tool Works

Diversified Machinery

2.47%

27.8%

JCOM

j2 Global

Internet Software & Services

2.53%

33.2%

KLAC

KLA-Tencor

Semiconductor Equipment & Materials

2.92%

36.0%

LMT

Lockheed Martin

Aerospace/Defense Products & Services

5.22%

49.5%

MDT

Medtronic

Medical Appliances & Equipment

2.33%

31.8%

MMM

3M

Conglomerates

2.45%

36.7%

MSFT

Microsoft

Application Software

3.31%

46.7%

NOC

Northrop Grumman

Aerospace/Defense - Major Diversified

3.33%

26.8%

NSU

Nevsun Resources

Gold

2.60%

11.6%

NTI

Northern Tier Energy

Oil & Gas Refining & Marketing

20.74%

0.0%

NUS

Nu Skin Enterprises

Personal Products

2.09%

21.8%

PDLI

PDL BioPharma

Biotechnology

8.53%

41.8%

QCOR

Questcor Pharmaceuticals

Biotechnology

2.59%

7.0%

RTN

Raytheon

Aerospace/Defense - Major Diversified

3.67%

35.1%

STX

Seagate Technology

Data Storage Devices

4.77%

18.0%

TWX

Time Warner

Entertainment - Diversified

2.17%

32.8%

USMO

USA Mobility

Wireless Communications

4.29%

45.1%

VCI

Valassis Communications

Marketing Services

4.60%

0.0%

WDC

Western Digital Corp.

Data Storage Devices

2.18%

5.8%

WSTG

Wayside Technology Group

Computers Wholesale

4.99%

55.1%

XLS

Exelis

Communication Equipment

3.81%

25.3%

Mean

3.59%

30.5%

Moreover, these stocks are reasonably priced:

Ticker

Company

P/E

P/S

P/B

P/FCF

AAPL

Apple

10.22

2.57

3.32

9.66

ACN

Accenture

19.03

1.74

11.32

23.05

ADP

Automatic Data Processing

21.87

2.7

4.63

58.08

AMGN

Amgen

15.73

3.86

3.44

BA

Boeing

15

0.71

9.88

12.93

BLC

Belo

9.67

1.18

3

6.56

CA

CA Technologies

12.4

2.39

2.05

12.21

CAT

Caterpillar

10.78

0.91

3.41

CL

Colgate-Palmolive

22.13

3.15

24.62

39.77

COH

Coach

12.89

2.67

6.31

21.92

CSCO

Cisco Systems

12.01

2.35

2

13.21

DELL

Dell

9.47

0.41

2.38

7.73

DGX

Quest Diagnostics

14.22

1.2

2.12

10.08

EBIX

Ebix

7.86

2.72

1.46

8.02

EMR

Emerson Electric

20.45

1.68

3.95

28.54

FCX

Freeport-McMoRan Copper & Gold

10.17

1.71

1.76

GIS

General Mills

16.85

1.72

4.22

28.06

HLF

Herbalife

9.48

1.02

10.69

13.18

HON

Honeywell International

18.89

1.45

4.19

38.5

INTC

Intel

9.59

1.9

1.99

ITW

Illinois Tool Works

11.6

1.59

2.7

JCOM

j2 Global

13.95

4.6

2.82

13.63

KLAC

KLA-Tencor

13.39

2.91

2.71

16.85

LMT

Lockheed Martin

10.54

0.6

734.33

MDT

Medtronic

14.38

2.77

2.63

15.76

MMM

3M

16.38

2.39

3.94

32.76

MSFT

Microsoft

15.25

3.19

3.21

11.25

NOC

Northrop Grumman

8.45

0.62

1.66

8.82

NSU

Nevsun Resources

4.52

1.2

1.25

4.28

NTI

Northern Tier Energy

6.44

0.58

4.88

16.67

NUS

Nu Skin Enterprises

10.85

1.03

3.8

PDLI

PDL BioPharma

5.13

2.72

8.2

QCOR

Questcor Pharmaceuticals

11.84

4.26

14.78

10.89

RTN

Raytheon

9.64

0.73

2.24

STX

Seagate Technology

4.21

0.7

3.91

3.73

TWX

Time Warner

17.15

1.72

1.65

27.62

USMO

USA Mobility

5.98

1.13

0.97

5.68

VCI

Valassis Communications

9.73

0.49

2.27

6.26

WDC

Western Digital Corp.

5.56

0.71

1.34

3.74

WSTG

Wayside Technology Group

10.87

0.2

1.9

XLS

Exelis

6.6

0.36

1.75

Mean

11.98

1.77

22.54

16.70

Median

10.87

1.68

2.91

12.93

Re-purposing the Magic Formula for dividend investing created a compelling portfolio. Its median holding price-to-earnings ratio of 10.87, and a price-to-sales ratio of 1.68. This is an attractively valued income portfolio.

*These price multiples should be averaged using a harmonic mean (ratios which are better when they are smaller usually should be averaged using the harmonic mean) but reporting the median value and algebraic mean is more straightforward for a general audience.

Disclaimer: This article was written to provide investor information and education, and should not be construed as investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing.

Source: Building A Magic Formula Dividend Portfolio