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I tried to create a good-yielding small-cap 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 very profitable companies that are included in the Russell 2000 index that pay rich dividends and that have a very low payout ratio. Those stocks would also have to show a very low debt.

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 2000 index.
  2. The stock does not trade over-the-counter (OTC).
  3. Market cap is greater than $100 million.
  4. Price is greater than 1.00.
  5. Dividend yield is greater than 2.0%.
  6. The payout ratio is less than 40%.
  7. Total debt to equity is less than 0.40.
  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 15, 2013, I discovered the following twenty stocks:

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The table below presents the dividend yield, the payout ratio, the trailing P/E, and the debt to equity for the twenty companies.

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TriCo Bancshares (NASDAQ:TCBK)

TriCo Bancshares operates as the holding company for Tri Counties Bank that provides commercial banking services to retail customers, and small to medium-sized businesses.

TriCo Bancshares has a very low debt (total debt to equity is only 0.20) and it has a low trailing P/E of 13.75 and a low forward P/E of 13.06. The price to free cash flow for the trailing 12 months is very low at 13.40, and the average annual earnings growth estimates for the next five years is quite high at 10%. The PEG ratio is at 1.37, and the price-to-cash ratio is extremely low at 0.56. The forward annual dividend yield is at 2.11%, and the payout ratio is only 24.8%. The annual rate of dividend growth over the past five years was quite high at 11.38%.

On July 25 TriCo Bancshares reported its latest quarter financial results. EPS came in at $0.39 in-line with expectations. The company reported earnings of $6,325,000, or $0.39 per diluted share, for the three months ended June 30, 2013. These results compare to earnings of $5,321,000, or $0.33 per diluted share reported by the company for the three months ended June 30, 2012. Total assets of the Company increased $62,313,000 (2.5%) to $2,587,931,000 at June 30, 2013 from $2,525,618,000 at June 30, 2012.

TriCo Bancshares has compelling valuation metrics, and good earnings growth prospects. In my opinion, TCBK stock still has room to go up. Furthermore, the solid dividend represents a nice income.

Since the company is rich in cash ($37.52 a share) and has a 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 a decline in the bank's interest margin.

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Chart: finviz.com

Brooks Automation Inc (NASDAQ:BRKS)

Brooks Automation, Inc. provides automation, vacuum, and instrumentation solutions for semiconductor manufacturing, life sciences, and technology device manufacturing markets worldwide.

Brooks Automation has no debt at all, and it has a very low trailing P/E of 5.68 and a forward P/E of 17.84. The PEG ratio is extremely low at 0.32, and the average annual earnings growth estimates for the next five years is very high at 18%. The price to book value is very low at 0.99, and the price-to-cash ratio is low at 5.96. The forward annual dividend yield is quite high at 3.44%, and the payout ratio is only 19.6%.

Brooks Automation has recorded strong revenue and EPS growth during the last three years, as shown in the table below.

Source: Portfolio123

On August 8, Brooks Automation reported its third-quarter fiscal 2013 results, which missed EPS expectations by $0.01.

Fiscal-Third Quarter of 2013 Financial and Operational Highlights:

  • Revenues were $118.1 Million; Order Bookings increased $6.8 million on a sequential basis to $128.1 million;
  • Brooks Life Science Systems Bookings increased to $18.5 million;
  • GAAP Earnings Per Share was $0.02; Adjusted Earnings Per Share excluding special charges was $0.03
  • Cash flow from Operations was $12.9 million;
  • Cash, Cash Equivalents and Marketable Securities as of June 30, 2013 were $150.7 million, or $2.26 per diluted share with no Debt;
  • Generated 17 Design-in-Wins for Semiconductor and Adjacent market customers.

(click to enlarge) Source: company presentation

Brooks Automation has compelling valuation metrics, strong earnings growth prospects, and the stock is trading below book value. In my opinion, BRKS stock can move higher. Furthermore, the rich dividend represents a nice income.

Since the company is rich in cash ($1.56 a share) and has no 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 a weakness in the electronics market.

(click to enlarge)

Chart: finviz.com

Golar LNG Ltd (NASDAQ:GLNG)

Golar LNG Limited, a midstream liquefied natural gas (LNG) company, engages in the transportation, regasification and liquefaction, and trading of LNG.

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Golar LNG Ltd has a very low debt (total debt to equity is only 0.21), and it has a very low trailing P/E of 2.97 and a forward P/E of 15.54. The current ratio is very high at 5.60, and the price-to-cash ratio is at 14.42. The forward annual dividend yield is high at 4.75%, and the payout ratio is only 12.9%.

The GLNG stock price is 3.88% above its 50-day simple moving average and 5.13% above its 200-day simple moving average. That indicates a mid-term and long-term uptrend.

Golar LNG Limited has recorded strong revenue and EPS growth during the last three years and the last five years, as shown in the table below.

Source: Portfolio123

On August 29, Golar LNG Limited reported its second-quarter financial results.

Second-Quarter Highlights

  • Golar LNG reports second quarter 2013 net income of $59.0 million (including a non-cash gain of $47.9 million on interest rate swaps).
  • EBITDA* generated in the quarter amounts to $8.2 million.
  • Underlying dividends received from Golar LNG Partners during the second quarter 2013 increase to $16.0 million from the first quarter level of $14.4 million.
  • Spot market remains volatile and inefficient, as a result the Hilli and Gandria enter layup in Indonesia.
  • Board maintains dividend at $0.45 for the quarter.

Golar LNG Limited has recorded strong revenue and EPS and growth, and considering its cheap valuation metrics, GLNG stock can move higher. Furthermore, the very rich dividend represents a gratifying income.

Risks to the expected capital gain and to the dividend payment include: a downturn in the U.S. economy, and decline in the price of natural gas.

(click to enlarge)

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 2000), 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 good-yielding small caps 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 2000 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 the one year and the fourteen years tests.

One-year return of the screen was high at 39.25%, while the return of the S&P 500 index during the same period was at 15.23% and that of the Russell 2000 index was at 22.18%.

The difference between the long-term 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 18.14%, while the average annual return of the S&P 500 index during the same period was only 2.18% and that of the Russell 2000 index was at 6.43%. The maximum drawdown of the screen was at 45.56%, while that of the S&P 500 was at 56.39% and the maximum drawdown of the Russell 2000 index was at 59.14%.

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

Source: Good-Yielding. Lower Risk Small-Cap Portfolio That Has Outperformed The Market