Good dividend yield, low payout ratio and consistent dividend growth are an essential combination for a long term successful dividend stocks strategy, but what about reducing the risk? In order to find out high-yielding stocks with high reward to risk ratio, I looked for stocks with high Sharpe ratio.
I have searched for companies with a high dividend yield and with a low payout ratio that consistently have raised dividend payments and have a high Sharpe ratio.
The screen's method requires all stocks to comply with all following demands:
- Market Cap is greater than $100 million.
- Last price is greater than 1.00.
- Dividend yield is greater than 4%.
- The payout ratio is less than 100%.
- The annual rate of dividend growth over the past five years is greater than zero.
- 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.
I used the Portfolio123's powerful screener and ranking system 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 June 20, 2013, I selected the first ranked ten stocks: Inergy LP (NRGY), Arlington Asset Investment Corp (AI), Lockheed Martin Corp (LMT), Shaw Communications Inc. (SJR), Main Street Capital Corp (MAIN), Triangle Capital Corp (TCAP), TAL International Group Inc (TAL), Universal Insurance Holdings (UVE), Alliance Holdings GP LP (AHGP) and Pioneer Southwest Energy Partners LP (PSE).
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 and the Sharpe ratio 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 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
Just a matter of curiosity, the table below presents the ten companies originated by the screen formula one year before, on June 16, 2012.
Five years back-test
The table below presents the ten companies originated by the screen formula on October 31, 2009.
Fourteen years back-test
The high-yielding 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, which measures the ratio of reward to risk, was also much better in all the three tests. Furthermore, the maximum drawdown, which normally is much bigger in a small portfolio than in the benchmarks, was much smaller in all the three tests.
One year return of the screen was at 25.84% while the return of the S&P 500 index during the same period was at 19.97%. The difference between the high-yielding stocks 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 20.83% while the average annual return of the S&P 500 index during the same period was only 1.97%. The maximum drawdown of the screen was at 36.04% while the maximum drawdown of the S&P 500 index during the same period was at 56.39%. In my opinion, long-term investing in this portfolio will reward the investor a nice income with a good chance of capital gain.