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In order to create a dividend stock portfolio that can outperform the market by a big margin, I have used the following screen. It is based on attempt to search for profitable companies which are included in the Russell 3000 index with dividend yield and dividend growth rates greater than their industry averages. Those companies would also have to show strong earnings growth prospects, and their last five years earnings growth should be greater than their industries' earnings growth.

The screen's method that I use to build this portfolio requires all stocks to comply with all of the following demands:

  1. Dividend yield is greater than the dividend yield of the industry.
  2. The payout ratio is less than 100%.
  3. The annual rate of dividend growth over the past five years is greater than the dividend growth of the industry.
  4. Average annual earnings growth estimates for the next 5 years is greater than 10%.
  5. Average annual earnings growth for the past 5 years is greater than the average annual earnings growth of the industry.
  6. The 8 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 June 29, 2013, I discovered the following eight stocks: Inergy LP (NRGY), Leggett & Platt Inc (NYSE:LEG), B&G Foods Holdings Corp (NYSE:BGS), Tupperware Brands Corp (NYSE:TUP), RPC Inc. (NYSE:RES), Herbalife Ltd (NYSE:HLF), CSX Corp (NYSE:CSX) and Calavo Growers Inc (NASDAQ:CVGW).

The table below presents the eight companies, their last price, their market cap and their industry.

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

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Back-testing

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 benchmarks (S&P 500, Russell 3000), 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

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Just a matter of curiosity, the table below presents the eight companies originated by the screen formula one year before, on June 28, 2012.

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Five years back-test

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The table below presents the eight companies originated by the screen formula on June 28, 2008.

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Fourteen years back-test

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The table below presents the eight companies originated by the screen formula on March 27, 1999.

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Summary

The strong dividend growth screen has given much better returns during the last year, the last five years and the last 14 years than the S&P 500 and the Russell 3000 benchmarks. 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 30.79% while the return of the S&P 500 index during the same period was at 19.22% and the return of the Russell 3000 was at 19.94%. The difference between the strong dividend growth screen to the benchmarks was much more noticeable in the 14 years back-test. The 14-year average annual return of the screen was at 16.28% while the average annual return of the S&P 500 index during the same period was only 1.86% and the return of the Russell 3000 was at 2.54%. Although this screening system has given superior results, I recommend readers use this list of stocks as a basis for further research.

Some additional information about the companies previously mentioned

Inergy LP

Inergy, L.P., an integrated energy midstream master limited partnership, engages in the storage and transportation of natural gas and natural gas liquids (NYSE:NGL) in the United States and Canada.

Inergy will report its latest quarterly financial results on July 29. Inergy is expected to post a profit of $0.04 a share, a $0.19 rise from the company's actual earnings for the same quarter a year ago. The reported results will probably affect the stock price in the short term.

Leggett & Platt Inc

Leggett & Platt, Incorporated designs and produces various engineered components and products worldwide.

Leggett & Platt will report its latest quarterly financial results on July 29. Leggett & Platt is expected to post a profit of $0.44 a share, a $0.01 decline from the company's actual earnings for the same quarter a year ago. The reported results will probably affect the stock price in the short term.

B&G Foods Holdings Corp

B&G Foods, Inc. and its subsidiaries engage in the manufacture, sale, and distribution of shelf-stable foods and household products in the United States, Canada, and Puerto Rico.

B&G Foods will report its latest quarterly financial results on July 22. BGS is expected to post a profit of $0.35 a share, a 6.1% rise from the company's actual earnings for the same quarter a year ago. The reported results will probably affect the stock price in the short term.

Tupperware Brands Corp

Tupperware Brands Corporation operates as a direct seller of various products across a range of brands and categories through an independent sales force worldwide.

Tupperware will report its latest quarterly financial results on July 24. TUP is expected to post a profit of $1.45 a share, a 10.7% rise from the company's actual earnings for the same quarter a year ago. The reported results will probably affect the stock price in the short term.

RPC Inc.

RPC, Inc. provides oilfield services and equipment for oil and gas companies engaged in the exploration, production, and development of oil and gas properties in the United States, Canada, Eastern Europe, Latin America, Africa, the Middle East, China, New Zealand.

RPC will report its latest quarterly financial results on July 22. RPC is expected to post a profit of $0.19 a share, a 42% decline from the company's actual earnings for the same quarter a year ago. The reported results will probably affect the stock price in the short term.

Herbalife Ltd

Herbalife Ltd., a network marketing company, sells weight management, healthy meals and snacks, sports and fitness, energy and targeted nutritional products, and personal care products worldwide.

Herbalife will report its latest quarterly financial results on July 29. HLF is expected to post a profit of $1.18 a share, a 7.2% rise from the company's actual earnings for the same quarter a year ago. The reported results will probably affect the stock price in the short term.

CSX Corp

CSX Corporation, together with its subsidiaries, provides rail-based transportation services. It offers traditional rail services, and transports intermodal containers and trailers.

CSX will report its latest quarterly financial results on July 16. CSX is expected to post a profit of $0.47 a share, a 4.0% decline from the company's actual earnings for the same quarter a year ago. The reported results will probably affect the stock price in the short term.

Calavo Growers Inc

Calavo Growers, Inc. markets and distributes avocados, prepared avocados, and other perishable foods to food distributors, produce wholesalers, supermarkets, convenience stores, and restaurants worldwide.

Source: Building A Strong Dividend Growth Portfolio