Building A Dividend Portfolio With A High Reward-To-Risk Ratio That Can Outperform The Market By A Big Margin

by: Arie Goren

I have searched for a good-yielding dividend portfolio that can outperform the market by a big margin with a high reward to risk ratio. For this purpose, I used in the screening formula the Sharpe Ratio.

Sharpe Ratio definition by Investopedia:

A ratio developed by Nobel laureate William F. Sharpe to measure risk-adjusted performance. The Sharpe ratio is calculated by subtracting the risk-free rate - such as that of the 10-year U.S. Treasury bond - from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.

I have searched for profitable companies that are included in the Russell 3000 index that pay rich dividends. Those companies would have to show also positive dividend growth over the past five years, and have Sharpe Ratio greater than one.

Russell 3000 index

Russell Investment explanation:

The Russell 3000 Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market. The Russell 3000 Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad market and is completely reconstituted annually to ensure new and growing equities are reflected.

The screen's method requires all stocks to comply with all following demands:

  1. Dividend yield is greater than 3.0%.
  2. The payout ratio is less than 100%.
  3. The annual rate of dividend growth over the past five years is positive.
  4. Sharpe Ratio is greater than 1.
  5. The 10 stocks with the highest Sharpe Ratio among all the stocks that complied with the first five demands.

I used 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 May 01, 2013, before the market open, I discovered the following 10 stocks: UNS Energy Corp (NYSE:UNS), Cincinnati Financial Corp (NASDAQ:CINF), American Electric Power Co Inc (NYSE:AEP), CMS Energy Corp (NYSE:CMS), Vectren Corp (NYSE:VVC), Plains All American Pipeline LP (NYSE:PAA), Black Hills Corp (NYSE:BKH), Atmos Energy Corp (NYSE:ATO), DTE Energy Co (NYSE:DTE) and Johnson & Johnson (NYSE:JNJ).

The table below presents the 10 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 10 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 five years, and the average annual earnings growth for the past five years for the 10 companies.


In order to find out how such a screening formula would have performed during the last year, last five years and last 14 years, I ran the back-tests, which are available from the screener.

The back-test takes into account running the screen every four weeks 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

14 years back-test


The high reward to risk ratio 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 was also much better in all the three tests. One year return of the screen was at 21.28% while the return of the S&P 500 index during the same period was at 14.29%. The difference between the high reward to risk ratio screen to the S&P 500 benchmark was much more noticeable in the 14 years back-test. The 14-year average annual return of the screen was at 15.59% while the average annual return of the S&P 500 index during the same period was only 1.85%. 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 have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.