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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 that pay rich dividends and that have raised their payouts at a high rate for the last three and five years.

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

  1. The stock is included in the Russell 3000 index.
  2. Price is greater than 1.00.
  3. Market cap is greater than $100 million.
  4. Dividend yield is greater than 2.0%.
  5. The payout ratio is less than 50%.
  6. The annual rate of dividend growth over the past three years is greater than 10%.
  7. The annual rate of dividend growth over the past five years is greater than 5%.
  8. The twenty stocks with the lowest payout ratio among all the stocks that complied with the first seven 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 September 02, 2013, I discovered the following twenty stocks:

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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, and the trailing P/E for the twenty companies.

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Helmerich & Payne Inc. (NYSE:HP)

Helmerich & Payne, Inc. engages in the contract drilling of oil and gas wells.

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Source: company presentation

Helmerich & Payne has a very low debt (total debt to equity is only 0.05), and it has a very low trailing P/E of 9.58 and a very low forward P/E of 11.52. The price-to-cash ratio is at 13.96, and the price to book value is at 1.56. The forward annual dividend yield is at 3.17%, and the payout ratio is only 6.60%. The annual rate of dividend growth over the past three years was high at 11.87% and over the past five years was also high at 9.24%.

Helmerich & Payne has recorded strong revenue, EPS and dividend growth, during the last year, the last three years and the last five years, as shown in the table below.

Source: Portfolio123

Helmerich & Payne has increased its market share by an impressive rate, as shown in the table below.

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Source: company presentation

On July 26 Helmerich & Payne reported its third-quarter fiscal 2013 financial results, which beat EPS expectations by $0.10 and was in-line on revenues. The company reported income from continuing operations of $250,978,000 ($2.32 per diluted share) from operating revenues of $840,197,000 for its third fiscal quarter ended June 30, 2013, compared to income from continuing operations of $149,943,000 ($1.38 per diluted share) from operating revenues of $819,785,000 during last year's third fiscal quarter, and income from continuing operations of $151,067,000 ($1.39 per diluted share) from operating revenues of $838,309,000 during the second fiscal quarter of 2013.

Helmerich & Payne has recorded strong revenue, EPS and dividend growth, and it continues to capture market share. Considering its good valuation metrics, HP stock can move higher. Furthermore, the rich dividend represents a nice income.

Since the company is rich in cash ($4.51 a share) and has a very low debt and its payout ratio is very low, there is hardly a risk that the company will reduce its dividend payment.

Risks to the expected capital gain and to the dividend payment include a downturn in the U.S. economy, and lower oil and natural gas prices.

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Chart: finviz.com

AFLAC Inc (NYSE:AFL)

Aflac Incorporated, through its subsidiary, American Family Life Assurance Company of Columbus, provides supplemental health and life insurance products.

Aflac Incorporated has a low debt (total debt to equity is only 0.36), and it has a very low trailing P/E of 8.03 and a very low forward P/E of 8.87. The price to free cash flow for the trailing 12 months is extremely low at 2.10, and the average annual earnings growth estimates for the next five years is at 5.75%. The forward annual dividend yield is at 2.42%, and the payout ratio is only 18.4%. The annual rate of dividend growth over the past three years was very high at 16.84% and over the past five years was also very high at 16.85%.

Aflac has recorded strong revenue, EPS and dividend growth, during the last year, the last three years and the last five years, as shown in the table below.

Source: Portfolio123

On July 30, Aflac reported its second-quarter financial results, which beat EPS expectations by $0.11 and beat on revenues. Total revenues rose 2.4% to $6.0 billion during the second quarter of 2013, compared with $5.9 billion in the second quarter of 2012. Net earnings were $889 million, or $1.90 per diluted share, compared with $483 million, or $1.03 per share, a year ago.

Aflac has recorded very strong revenue, EPS and dividend growth, and considering its compelling valuation metrics and its solid earnings growth prospects, AFL stock can move higher. Furthermore, the rich dividend represents a nice income.

Since a significant portion of Aflac's business is in Japan, where the functional currency is the yen, the impact from translating yen into dollars might reduce Aflac's operating earnings, in case of decrease in the exchange rate of the yen.

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Chart: finviz.com

American Railcar Industries Inc (NASDAQ:ARII)

American Railcar Industries, Inc. designs, manufactures, and sells hopper and tank railcars in North America.

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American Railcar Industries has a relatively low debt (total debt to equity is 0.50), and it has a very low trailing P/E of 9.43 and a very low forward P/E of 8.28. The PEG ratio is very low at 0.63, and the average annual earnings growth estimates for the next five years is high at 15%. The forward annual dividend yield is at 2.83%, and the payout ratio is only 15.8%. The annual rate of dividend growth over the past three years was very high at 60.91%, and over the past five years was also high at 15.81%.

American Railcar Industries has recorded strong EPS and dividend growth and mild revenue growth, during the last three years and the last five years, as shown in the table below.

On July 24, American Railcar Industries reported its second-quarter financial results, which beat EPS expectations by $0.29 and missed on revenues.

Second Quarter 2013 Highlights

  • Record consolidated operating margins of 25%
  • Consolidated earnings from operations of $39.9 million
  • Consolidated Revenues totaled $159.4 million
  • Adjusted EBITDA of $43.0 million
  • Net earnings of $23.6 million, or $1.11 per share

At the board meeting in July, the Company's board of directors declared a cash dividend of $0.25 per share of common stock of the Company to shareholders of record as of September 20, 2013 that will be paid on September 27, 2013.

American Railcar Industries has recorded very strong EPS and dividend growth, and considering its compelling valuation metrics and its strong earnings growth prospects, ARII stock can move higher. Furthermore, the rich dividend represents a nice income.

Since the company is rich in cash ($4.38 a share) and has a relatively low debt and its payout ratio is very low, there is hardly a risk that the company will reduce its dividend payment.

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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 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 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 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 high at 33.11%, while the return of the S&P 500 index during the same period was at 16.53% and that of the Russell 3000 index was at 18.50%.

The difference between the dividend growth 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 13.41%, while the average annual return of the S&P 500 index during the same period was only 1.96% and that of the Russell 3000 index was at 2.66%. The maximum drawdown of the screen was at 59.11%, 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.

Disclosure: I am long AFL. 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.

Source: Creating A Strong Dividend Growth Portfolio