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A good dividend yield, low payout ratio and consistent dividend growth are an essential combination for a successful dividend stock strategy, but what about reducing the risk? In order to find out good-yielding stocks with high reward-to-risk ratio, I looked for stocks with a high Sharpe ratio.

I have searched for companies with a healthy dividend yield and with a low payout ratio that consistently have raised dividend payments and have a high Sharpe 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 the following demands:

  1. The stock does not trade over-the-counter (OTC).
  2. Market cap is greater than $100 million.
  3. Price is greater than 1.00.
  4. Dividend yield is greater than 2.5%.
  5. Last dividend declared is greater or equal to the last dividend paid.
  6. The payout ratio is less than 75%.
  7. The annual rate of dividend growth over the past three years is greater than zero.
  8. Total debt to equity is less than 0.50.
  9. Sharpe ratio is greater than 1.0.
  10. The 20 stocks with the lowest payout ratio among all the stocks that complied with the first nine 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 and finviz.com.

After running this screen on October 7, 2013, before the market open, I discovered the following 20 stocks:

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The table below presents the dividend yield, the payout ratio, the annual rate of dividend growth over the past three years, and the Sharpe ratio, for the 20 companies.

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EMC Insurance Group Inc. (NASDAQ:EMCI)

EMC Insurance Group Inc., an insurance holding company, engages in property and casualty insurance, and reinsurance activities. It operates in two segments, Property and Casualty Insurance, and Reinsurance.

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Source: company presentation

EMC Insurance Group has a very low debt (total debt to equity is only 0.07), and it has a very low trailing P/E of 9.30 and a very low forward P/E of 10.73. The price-to-sales ratio is very low at 0.74, and the price-to-book value is also low at 0.97. The price to free cash flow is very low at 6.62, and the average annual earnings growth estimates for the next five years is at 5%. The forward annual dividend yield is at 2.80%, and the payout ratio is only 25.7%. The annual rate of dividend growth over the past three years was at 4% and over the past five years was at 3.26%.

The EMCI stock price is 3.60% above its 20-day simple moving average, 4.00% above its 50-day simple moving average and 11.21% above its 200-day simple moving average. That indicates a short-term, mid-term and long-term uptrend.

EMC Insurance Group has recorded revenue and dividend growth, during the last year, the last three years and the last five years, as shown in the charts below.

Source: Portfolio123

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Source: company presentation

EMC Insurance Group will report its latest quarterly financial results on November 4. EMCI is expected to post a profit of $0.51 a share, a $0.14 decline from the company's actual earnings for the same quarter a year ago.

EMC Insurance Group has compelling valuation metrics and solid earnings growth prospects, and considering the fact that the stock is trading below book value and it is in an uptrend, EMCI stock can move higher. Furthermore, the EMCI rich dividend represents a nice income.

Risks to the expected capital gain and to the dividend payment include: a downturn in the U.S. economy, and above-average catastrophes and other large loss activity.

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Chart: finviz.com

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 11.22 and a low forward P/E of 13.46. The price-to-book value is at 1.83, and the average annual earnings growth estimates for the next five years is at 1.5%. The forward annual dividend yield is at 2.71%, 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%.

The HP stock price is 6.98% above its 20-day simple moving average, 10.95% above its 50-day simple moving average and 17.49% above its 200-day simple moving average. That indicates a short-term, mid-term and long-term uptrend.

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 chart 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

Horace Mann Educators Corp. (NYSE:HMN)

Horace Mann Educators Corporation, through its subsidiaries, operates as a multi-line insurance company in the United States.

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Source: company presentation

Horace Mann Educators has a very low debt (total debt to equity is only 0.21), and it has a very low trailing P/E of 10.17 and a very low forward P/E of 12.86. The price to free cash flow is very low at 6.94, and the price-to-sales ratio is at 1.11. The price-to-book value is low at 1.04, and the average annual earnings growth estimates for the next five years is at 8%. The forward annual dividend yield is at 2.70%, and the payout ratio is only 23.9%. The annual rate of dividend growth over the past three years was very high at 32.30% and over the past five years was at 5.54%.

The HMN stock price is 4.64% above its 20-day simple moving average, 4.47% above its 50-day simple moving average and 22.91% above its 200-day simple moving average. That indicates a short-term, mid-term and long-term uptrend.

Analysts recommend the stock. Among the two analysts covering the stock, one rates it as a strong buy and one rates it as a buy.

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

Source: Portfolio123

On July 24, Horace Mann reported its second-quarter results, which beat EPS expectations by $0.07. In the report, Horace Mann's President and CEO Peter H. Heckman said:

Horace Mann's second-quarter operating income was $0.39 per share, a solid result considering the higher than anticipated level of catastrophe losses in the quarter. Compared to the second quarter and first six months of 2012, both the reported and underlying property and casualty combined ratios improved, while written and earned premiums increased 3%. In the annuity segment, assets under management increased 10% over prior year, more than offsetting the modest impact of spread compression, with deferred policy acquisition cost unlocking, also benefitting the quarterly earnings comparison to the prior year. In the life segment, second quarter sales of Horace Mann products increased 31% compared to a year earlier, with the anticipated decline in earnings reflecting more normalized mortality losses and a slight decrease in investment income.

Horace Mann Educators has recorded strong EPS and dividend growth, and considering its cheap valuation metrics and its solid earnings growth prospects, HMN stock can move higher. Furthermore, the rich dividend represents a nice income.

Risks to the expected capital gain and to the dividend payment include; a downturn in the U.S. economy, and higher-than-anticipated level of catastrophe losses.

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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 15 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.

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-year back-test

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15-year back-test

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Summary

The good-yielding screen has given much better returns during the last year, the last five years and the last 15 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 benchmark, was much smaller in all the three tests.

One-year return of the screen was at 29.24%, while the return of the S&P 500 index during the same period was at 14.97%.

The difference between the good-yielding screen to the benchmark was even more noticeable in the 15 years back-test. The 15-year average annual return of the screen was at 15.85%, while the average annual return of the S&P 500 index during the same period was only 2.18%. The maximum drawdown of the screen was only 27.17%, while that of the S&P 500 was at 57%.

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 Dividend Portfolio With High Reward-To-Risk Ratio