Which Of The Russell 3000 Financial Companies Is Most Attractive To Dividend Investors?

Includes: AFL, AI, DFS, HMN, PRE, SLM
by: Arie Goren

Almost all financial companies pay dividends. Among the 600 financial companies that are included in the Russell 3000 index, 500 companies pay dividends. The average annual dividend yield of these companies is 3.71% while the median is 2.98%. American Capital Agency Corp (NASDAQ:AGNC) has the highest yield at 19.56%, and Radian Group Inc. (NYSE:RDN) has the lowest yield at 0.08%.

In this article, I tried to determine which of the Russell 3000 financial companies is the most attractive for dividend-seeking investors.

Russell 3000 Index

Description from Russell Investments:

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.

I consider that besides a healthy dividend yield, low payout ratio and consistent dividend growth are the most crucial factors for dividend-seeking investors. In addition, since dividend investors try to avoid too much risk, The Sharpe ratio-- which measures the ratio of reward to risk-- is also extremely important.

Explanation of Sharpe Ratio

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.

The Sharpe ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been. A negative Sharpe ratio indicates that a risk-less asset would perform better than the security being analyzed.

I have screened the Russell 3000 financial companies that pay dividends according to the above-mentioned principles.

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

  1. The payout ratio is less than 100%.
  2. The annual rate of dividend growth over the past five years is greater than zero.
  3. The forward dividend rate is equal or greater than the trailing dividend rate.
  4. Sharpe ratio is greater than 1.0.

Furthermore, I ranked all the stocks that complied with all the required demands according to a formula that I constructed, which gave 35% weight to the yield, 35% to the payout ratio, 20% to the dividend growth and 10% to the Sharpe ratio.

In order to find out how such a ranking formula would have performed during the last 14 years, I ran a back-test, which is available by the Portfolio123's screener. For the back-test, I took the 406 Russell 3000 companies that pay dividends and comply with all the above-mentioned demands.

The back-test results are shown in the chart below. For the back-test, I divided the 406 companies into ten groups according to their ranking. The highest ranked group with the ranking score of 90-100, which is shown by the dark green column in the chart, has given by far the best return, an average annual return of almost 21%. Also, the second and the third group (scored: 80-90 and 70-80) have given superior returns. This brings me to the conclusion that my ranking system is useful.

I used the Portfolio123's powerful screener and ranking system to perform the search. All the data for this article were taken from Portfolio123. After running this screen on June 10, 2013, before the market open, I discovered 59 financial stocks which comply with all the demands.

The table below presents the best twenty companies in the order of their rank.

The table below presents the dividend yield, the payout ratio, the annual rate of dividend growth over the past five years and the Sharpe ratio for the twenty companies.

The table below shows the most influential parameters, for dividend-seeking investors, for the six best ranked Russell 3000 financial companies according to my criteria.

Chart: finviz.com

Chart: finviz.com

Chart: finviz.com

Chart: finviz.com

Chart: finviz.com

Chart: finviz.com


Which of the six financial companies is the most attractive for dividend-seeking investors? It is not easy to determine. All the six stocks look quite attractive to dividend-seeking investors due to their solid dividend and their long-term track record of consistent and rising dividend payments. Arlington Asset Investment Corp (NYSE:AI) has the highest yield among the six companies, but its Sharpe ratio is the lowest at 1.42. SLM Corp (NYSE:SLM) has the highest Sharpe ratio among the six companies, but it has very high debt. AFLAC Inc (NYSE:AFL) has a solid yield of 2.45% and all its valuation parameters are quite good. Discover Financial Services Inc (NYSE:DFS) has a yield of 1.64%, the lowest among the six companies. Horace Mann Educators Corporation (NYSE:HMN) has a good yield of 3.16% and all its valuation parameters are quite good. PartnerRe Ltd. (NYSE:PRE) has the lowest debt-to-equity ratio among the six companies, and all its valuation parameters are quite good.

Considering all these factors, I can't see one stock, which is clearly superior to the others. In my opinion, a portfolio of the three stocks: AFL, HMN and PRE can give a satisfying long term return to the dividend investor.

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.