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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 an attempt to search for very profitable companies that pay rich dividends and that have raised their payouts at a high rate for the last three and five years.

In many of my previous screens, the demand was to rebalance the portfolio every four weeks and replace the stocks that no longer comply with the screening requirement with other stocks that comply with the requirement. Since most investors do not have the opportunity to rebalance the portfolio every four weeks, in the following screen the demand is to rebalance the portfolio only twice a year.

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

  1. The stock does not trade over-the-counter (OTC).
  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 and finviz.com.

After running this screen on October 11, 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 annual rate of dividend growth over the past five years, and the trailing P/E ratio, for the twenty companies.

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L-3 Communication Holdings Inc. (NYSE:LLL)

L-3 Communication Holdings, Inc. provides command, control, communications, intelligence, surveillance, and reconnaissance systems; aircraft modernization and maintenance; and national security solutions in the United States and internationally.

L-3 Communication Holdings has a very low trailing P/E of 11.18 and a very low forward P/E of 11.45. The price to free cash flow is very low at 9.86, and the price-to-sales ratio is also very low at 0.64. The forward annual dividend yield is at 2.35%, and the payout ratio is at 25.3%. The annual rate of dividend growth over the past three years was high at 12.62% and over the past five years was also high at 14.87%.

L-3 Communication Holdings has recorded EPS and dividend growth, during the last year, the last three years and the last five years, as shown in the table below.

L-3 Communication Holdings' trailing and forward P/E ratios have been much better than that of the industry median, the sector median and the S&P 500 median, as shown in the table below.

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Source: Portfolio123

L-3 Communication Holdings will report its latest quarterly financial results on October 28. LLL is expected to post a profit of $1.95 a share, a $0.03 decline from the company's actual earnings for the same quarter a year ago.

L-3 Communication Holdings has recorded EPS and dividend growth, and considering its compelling valuation metrics, LLL stock can move higher. Furthermore, the rich dividend represents a nice income.

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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 11.10 and a very low forward P/E of 9.74. The PEG ratio is very low at 0.74, and the average annual earnings growth estimates for the next five years is high at 15%. The forward annual dividend yield is at 2.40%, and the payout ratio is only 20%. 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%.

The ARII stock price is 7.57% above its 20-day simple moving average, 12.40% above its 50-day simple moving average and 13.28% above its 200-day simple moving average. That indicates a short-term, mid-term and long-term uptrend.

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.

American Railcar Industries' trailing and forward P/E ratios have been much better than that of the industry median, the sector median and the S&P 500 median, as shown in the table below.

(click to enlarge)

American Railcar Industries will report its latest quarterly financial results in October. ARII is expected to post a profit of $0.99 a share, a 38% rise from the company's actual earnings for the same quarter a year ago.

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

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

Corning Inc. (NYSE:GLW)

Corning Incorporated produces and sells specialty glasses, ceramics, and related materials worldwide.

Corning has a very low debt (total debt to equity is only 0.14), and it has a very low trailing P/E of 11.12 and a very low forward P/E of 10.20. The PEG ratio is very low at 0.93, and the average annual earnings growth estimates for the next five years is quite high at 12%. The forward annual dividend yield is at 2.77%, and the payout ratio is only 27%. The annual rate of dividend growth over the past three years was very high at 16.35% and over the past five years was also very high at 25.79%.

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

Corning's margins have been much better than that of the industry median, the sector median and the S&P 500 median, as shown in the table below.

(click to enlarge)

Corning's returns on capital have been much better than that of the industry median, the sector median and the S&P 500 median, as shown in the table below.

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Corning's trailing and forward P/E ratios have been much better than that of the industry median, the sector median and the S&P 500 median, as shown in the table below.

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Corning will report its latest quarterly financial results on October 30. GLW is expected to post a profit of $0.32 a share, a $0.02 decline from the company's actual earnings for the same quarter a year ago.

On July 30, Corning reported its second-quarter results, which beat EPS expectations by $0.01 and beat on revenues.

Second-quarter performance highlights

  • Core sales were $2.0 billion, an increase of 11% over the same period of 2012. Net sales (GAAP) for the quarter were $2.0 billion.
  • Core earnings per share were $0.32, representing a 23% improvement over the second quarter of 2012 and the third consecutive quarter of year-over-year double-digit growth. GAAP earnings per share were $0.43, compared with $0.31 a year ago, a 39% increase.
  • In the Display Technologies segment, second-quarter LCD glass price declines were moderate and less than the previous quarter.
  • Sales and net income in Corning's Telecommunications segment improved significantly on both a year-over-year and sequential basis.

Corning has innovating products and it has compelling valuation metrics and good earnings growth prospects, In my opinion, GLW stock still has room to go up. Furthermore, the rich dividend represents a nice income.

Since the company is rich in cash ($3.72 a share) and has 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 a significant decline in LCD glass price.

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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 six months 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-test 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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Fifteen 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 fifteen 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.

One-year return of the screen was high at 29.26%, while the return of the S&P 500 index during the same period was at 18.14%.

The difference between the strong dividend growth 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 14.99%, while the average annual return of the S&P 500 index during the same period was only 2.19%. The maximum drawdown of the screen was at 50%, 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.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GLW over the next 72 hours. 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: A Strong Dividend Growth Portfolio That Can Outperform By A Big Margin