In my previous post, I tried to create a dividend stock portfolio that can outperform the market by a big margin. In that case, I created a screening method that shows such promise, but the demand was to rebalance the portfolio every four weeks and replace the stocks that no longer comply with the screening requirement with other stocks that comply with the requirement. Since most investors do not have the opportunity to rebalance the portfolio every four weeks, I created a new screening method that requires rebalancing the portfolio just once a year.
I have searched for profitable companies that are included in the S&P 500 and have dividend yield and dividend growth rate greater than their industries' dividend yield and dividend growth. Those companies would have to show also solid earnings growth prospects, and that their last five years earnings growth is greater than their industries' earnings growth.
S&P 500 index
Widely regarded as the best single gauge of the U.S. equities market, this world-renowned index includes 500 leading companies in leading industries of the U.S. economy. Although the S&P 500® focuses on the large cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. S&P 500 is part of a series of S&P U.S. indices that can be used as building blocks for portfolio construction.
The screen's method requires all stocks to comply with all following demands:
- Dividend yield is greater than the dividend yield of the industry.
- The payout ratio is less than 100%.
- The annual rate of dividend growth over the past five years is greater than the dividend growth of the industry.
- Average annual earnings growth estimates for the next 5 years is greater than > 5%.
- Average annual earnings growth for the past 5 years is greater than the average annual earnings growth of the industry.
- The 10 stocks with the highest yield among all the stocks that complied with the first five demands.
I used the Portfolio123's powerful screener to perform the search and to run back-tests. Nonetheless, the screening method should only serve as a basis for further research. All the data for this article were taken from Portfolio123.
After running this screen on April 30, 2013, I discovered the following ten stocks: Lorillard Inc (NYSE:LO), Southern Co (NYSE:SO), CA Inc (NASDAQ:CA), Raytheon Co. (NYSE:RTN), Leggett & Platt Inc (NYSE:LEG), KLA-Tencor Corp (NASDAQ:KLAC), General Mills Inc. (NYSE:GIS), McDonald's Corp (NYSE:MCD), Clorox Co (NYSE:CLX) and SLM Corp (NASDAQ:SLM).
The table below presents the ten companies, their last price, their market cap and their industry.
The table below presents the dividend yield, the payout ratio, the annual rate of dividend growth over the past five years, the Trailing P/E, the forward P/E and the PEG ratio for the ten companies.
The table below presents the current ratio, the price-to-sales ratio, the price to book value, the average annual earnings growth estimates for the next 5 years, and the average annual earnings growth for the past 5 years for the ten companies.
In order to find out how such a screening formula would have performed during the last year, last 5 years and last 14 years, I ran the back-tests, which are available by the Portfolio123's screener.
The back-test takes into account running the screen once a year and replacing the stocks that no longer comply with the screening requirement with other stocks that comply with the requirement. The theoretical return is calculated in comparison to the benchmark (S&P 500), considering 0.25% slippage for each trade and 1.5% annual carry cost (broker cost). The back-tests results are shown in the charts and the tables below.
One year back-test
Five years back-test
Fourteen years back-test
The long-term dividend screen has given much better returns during the last year, the last five years and the last 14 years than the S&P 500 benchmark. The Sharpe ratio, which measures the ratio of reward to risk, was also much better in all the three tests. One year return of the screen was at 22.19% while the return of the S&P 500 index during the same period was at 13.35%. The 14-year average annual return of the screen was at 7.66% while the average annual return of the S&P 500 index during the same period was only 1.78%. Although the past guarantees nothing, it does provide insight into how this screen has performed under various economic conditions over varying time frames.
Disclosure: I am long CA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.