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I tried to create a high-yielding stock portfolio that can outperform the market by a big margin, but at the same time, would have a very low risk. The following screen shows such promise. I have searched for profitable companies that are included in the Russell 3000 index that pay very rich dividends and their last dividend declared is greater than the last dividend paid.

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

  1. Price is greater than 1.00.
  2. Market cap is greater than $100 million.
  3. Dividend yield is greater than 3.0%.
  4. The payout ratio is less than 100%.
  5. Last dividend declared is greater than the last dividend paid.
  6. Debt to equity is less than 1.00.
  7. The twenty stocks with the highest dividend yield among all the stocks that complied with the first six demands.

I used the Portfolio123's powerful screener to perform the search and 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 August 23, 2013 before the market open, I discovered the following twenty stocks:

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The table below presents the dividend yield, the payout ratio, the last quarterly dividend declared, and the debt-to-equity ratio for the twenty companies.

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KKR & Co LP (NYSE:KKR)

Kohlberg Kravis Roberts & Co. is a private equity investment firm specializing in acquisitions, leveraged buyouts, management buyouts, special situations, growth equity, mature, and middle market investments.

Kohlberg Kravis Roberts has a very low trailing P/E of 12.21 and a very low forward P/E of 8.34. The price to free cash flow for the trailing 12 months is extremely low at 0.91. The forward annual dividend yield is very high at 8.42%, and the payout ratio is at 78.1%.

Analysts recommend the stock. Among the 14 analysts covering the stock, five rate it as a strong buy, six rate it as a buy, and three rate it as a hold.

On July 26, KKR reported its second-quarter results, which missed EPS expectations by $0.02. Total distributable earnings were $403.8 million for the quarter ended June 30, 2013, down from $406.1 million for the quarter ended June 30, 2012. Total distributable earnings were $694.4 million for the six months ended June 30, 2013, up from $570.2 million in the comparable period of 2012.

Although KKR missed second-quarter EPS expectations, its valuation metrics are compelling, and it is strongly recommended by analysts. In my opinion, an investor in KKR stock can expect a capital gain along with the very rich dividend.

Risks to the expected capital gain and to the high dividend payment include a downturn in the U.S. economy, and the company's debt of $1.80 billion.

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Chart: finviz.com

Nam Tai Electronics Inc (NTE)

Nam Tai Electronics, Inc. provides electronics manufacturing and design services to the original equipment manufacturers of telecommunication and consumer electronic products. The company was founded in 1975 and is based in Shenzhen, the People's Republic of China.

Nam Tai Electronics has no debt at all, and it has an extremely low trailing P/E of 4.59. The PEG ratio is exceptionally low at 0.37, and the average annual earnings growth estimates for the next five years are quite high at 12.50%. The price to free cash flow for the trailing 12 months is very low at 6.98, and the price-to-book-value ratio is also very low at 0.90. The forward annual dividend yield is very high at 8.09%, and the payout ratio is only 26.6%.

On August 5, Nam Tai Electronics reported its second-quarter results. Net sales in the second quarter of 2013 were $167.9 million, excluding the discontinued LCMs for tablets business of $30.7 million, an increase of 64.1%, compared to the net sales of $102.3 million, excluding the discontinued businesses of $113.7 million, for the same quarter of 2012. Gross profit in the second quarter of 2013 was $15.7 million, an increase of 2.7%, compared to $15.3 million in the second quarter of last year. Gross profit margin for the second quarter of 2013 was 9.4%, a decrease of 5.6%, compared to 15.0% in the second quarter of last year. Operating income for the second quarter of 2013 was $8.4 million, a decrease of 14.3%, compared to $9.8 million in the second quarter of last year. Net loss in the second quarter of 2013 was $31.9 million, or negative $0.71 per diluted share, compared to net income of $9.4 million, or $0.21 per diluted share, in the second quarter of last year.

Although Nam Tai's valuation metrics are excellent, and it is rich in cash ($4.41 a share) and has no debt, NTE stock is very volatile and quite dangerous.

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Chart: finviz.com

Hercules Technology Growth Capital Inc (NYSE:HTGC)

Hercules Technology Growth Capital, Inc. is a private equity, venture capital, and venture debt firm specializing in providing debt and equity to privately held venture capital and private equity backed companies and select publicly-traded companies.

Hercules Technology has a trailing P/E of 17.05 and a very low forward P/E of 11.48. The average annual earnings growth estimates for the next five years is at 5%. The forward annual dividend yield is very high at 7.59%, and the payout ratio is at 78%.

On August 01, Hercules Technology reported its second-quarter financial results, which beat EPS expectations by $0.06 and beat on revenues. Better-than-expected results were primarily driven by an improvement in total investment income, marginally offset by higher expenses. Overall, Hercules ended the quarter with an impressive performance, comprising a higher level of liquidity.

The HTGC stock price is 3.87% above its 20-day simple moving average, 7.36% above its 50-day simple moving average and 23.14% above its 200-day simple moving average. That indicates a short-term, mid-term and long-term uptrend.

Since HTGC valuation metrics are low, and the latest quarter financial results were very good, a capital gain can be expected along the very rich dividend.

Risks to the expected capital gain and to the high dividend payment include a downturn in the U.S. economy, and the company's debt of $557 million.

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Chart: finviz.com

Main Street Capital Corp (NYSE:MAIN)

Main Street Capital Corporation is a business development company specializing in equity, equity related, and debt investments in small and lower middle market companies.

Main Street Capital has a very low trailing P/E of 9.27 and a low forward P/E of 13.30. The average annual earnings growth estimates for the next five years is at 7.0%. The forward annual dividend yield is very high at 6.60%, and the payout ratio is at 51.9%. The annual rate of dividend growth for the last year was at 10.38%, for the last three years was at 5.37%, and over the past five years was at 9.22%.

On August 8, Main Street Capital reported its second-quarter financial results, which beat EPS expectations by $0.05.

Second-Quarter 2013 Highlights

  • Total investment income of $27.8 million, representing a 33% increase from the second quarter of 2012
  • Net investment income of $17.8 million (or $0.51 per share), representing a 39% increase from the second quarter of 2012
  • Distributable net investment income of $18.4 million (or $0.53 per share), representing a 38% increase from the second quarter of 2012
  • Net Asset Value of $18.72 per share at June 30, 2013, which represents an increase of $0.48 per share, or 3%, after excluding the effect of the $0.35 per share special dividend paid in January 2013, compared to $18.59 per share at December 31, 2012
  • Paid regular monthly dividends of $0.465 per share, or $0.155 per share for each of April, May and June 2013, representing an 11% increase compared to the second quarter of 2012 regular monthly dividends
  • Declared regular monthly dividends of $0.465 per share, or $0.155 per share for each of July, August and September 2013, representing a 7% increase compared to the third quarter of 2012
  • Declared semi-annual supplemental cash dividend of $0.20 per share payable in July 2013

Main Street Capital Corporation has recorded strong revenue, EPS and dividend growth during, the last three years and the last five years; the annual rate of revenue growth over the past five years was at 48.64%, the EPS growth was at 63.73, and the dividend growth was at 9.22%

Since MAIN valuation metrics are very low, and the company growth prospects are solid, a capital gain can be expected along the very rich dividend.

Risks to the expected capital gain and to the high dividend payment include a downturn in the U.S. economy and the company's debt of $519 million.

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Chart: finviz.com

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 through 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 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.

Since some readers could not get the same results that I got in some of my previous posts, I am giving, in the charts below, the Portfolio123 exact codes, which I used for building this screen and the back-tests. The number of stocks left after each demand can also be seen in the chart.

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One year back-test

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Five years back-test

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Fourteen years back-test

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Summary

The high-yielding 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 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. 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 high at 24.77%, while the return of the S&P 500 index during the same period was at 16.23% and that of the Russell 3000 index was at 18.71%.

The difference between the high-yielding dividend screen to the benchmarks was even more noticeable in the 14 years back-test. The 14-year average annual return of the screen was at 15.60%, while the average annual return of the S&P 500 index during the same period was only 2.00% and that of the Russell 3000 index was at 2.71%. The maximum drawdown of the screen was at 48.13%, while that of the S&P 500 was at 56.39% and the maximum drawdown of the Russell 3000 index was at 57.07%.

Although this screening system has given superior results, I recommend readers use this list of stocks as a basis for further research.

Source: High-Yielding Dividend Growth Portfolio With Very Low Risk