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I tried to create a dividend portfolio that can outperform the market by a big margin, but at the same time, would have a low risk. The following screen, which draws inspiration from the work of the well-known investor Ben Graham, shows such promise. This screen is available on Portfolio123's All-Stars list.

The screen's method requires all stocks to comply with all following demands:

  1. The stock does not trade over-the-counter (OTC).
  2. Current ratio is at least 1.50.
  3. Long-term debt is less than 110% of working capital.
  4. Last 4 quarters of EPS above breakeven.
  5. Last 5 years of EPS above breakeven.
  6. Annual EPS grew over past year and past 5 years.
  7. Company has paid dividends within past year.
  8. The twenty stocks with the best ranking according to Graham principles among all the stocks that complied with the first seven demands (the ranking system is available on Portfolio123's All-Stars list).

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 Yahoo Finance, Portfolio123 and finviz.com.

After running this screen on October 22, 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 current ratio, and the trailing P/E ratio, for the twenty companies.

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HollyFrontier Corp (NYSE:HFC)

HollyFrontier Corporation operates as an independent petroleum refiner and marketer in the United States.

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Source: company presentation

HollyFrontier has a very low debt (total debt to equity is only 0.16), and it has a very low trailing P/E of 5.79 and a very low forward P/E of 11.20. The price to free cash flow for the trailing 12 months is very low at 14.29, and the price-to-sales ratio is also very low at 0.44. The forward annual dividend yield is at 2.67%, and the payout ratio is only 42.5%. The annual rate of dividend growth over the past five years was very high at 21.14%.

The HFC stock price is 6.20% above its 20-day simple moving average and 4.21% above its 50-day simple moving average. That indicates a short-term and a mid-term uptrend.

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

Source: Portfolio123

Most of HollyFrontier's stock valuation parameters have been better than its industry median, sector median and the S&P 500 median, as shown in the table below.

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Source: Portfolio123

The chart below emphasizes the continuous cash returned by the company to its shareholders.

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Source: company presentation

HollyFrontier will report its latest quarterly financial results on November 06. HFC is expected to post a profit of $0.66 a share.

HollyFrontier has recorded strong revenue, EPS and dividend growth, and considering its compelling valuation metrics, HFC 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 lower refining margins.

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Chart: finviz.com

Joy Global, Inc. (NYSE:JOY)

Joy Global Inc. engages in the manufacture and servicing of mining equipment for the extraction of coal, copper, iron ore, oil sands, and other minerals.

Joy Global has a low debt (total debt to equity is only 0.44), and it has a very low trailing P/E of 8.07 and a low forward P/E of 14.50. The price to free cash flow for the trailing 12 months is very low at 14.98, and the PEG ratio is also very low 0.78. The price-to-sales ratio is at 1.06, and the average annual earnings growth estimates for the next five years is quite high at 10.33%. The forward annual dividend yield is at 1.27%, and the payout ratio is only 10.3%. The annual rate of dividend growth over the past five years was at 3.13%.

The JOY stock price is 3.94% above its 20-day simple moving average and 3.72% above its 50-day simple moving average. That indicates a short-term and a mid-term uptrend.

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

Joy Global's margins and stock valuation parameters have been much better than those of the industry median, the sector median and the S&P 500 median, as shown in the tables below.

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Joy Global will report its latest quarterly financial results on December 10. JOY is expected to post a profit of $1.10 a share.

Joy Global has recorded strong revenue and EPS and dividend growth, and considering its compelling valuation metrics and its good earnings growth prospects, JOY stock can move higher. Furthermore, the solid dividend represents a nice income.

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Chart: finviz.com

Valmont Industries, Inc. (NYSE:VMI)

Valmont Industries, Inc. produces and sells fabricated metal products in the United States, Australia, China, France, and internationally.

Valmont Industries has a low debt (total debt to equity is only 0.31), and it has a very low trailing P/E of 12.47 and a very low forward P/E of 11.94. The PEG ratio is very low 0.99, and the average annual earnings growth estimates for the next five years is quite high at 12.70%. The forward annual dividend yield is at 0.75%, and the payout ratio is only 8.31%. The annual rate of dividend growth over the past five years was high at 15.83%.

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

Valmont Industries' return on capital and stock valuation parameters have been much better than those of the industry median, the sector median and the S&P 500 median, as shown in the tables below.

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On October 17, Valmont Industries reported its third-quarter 2013 financial results.

Third-quarter Highlights

  • Third quarter sales increased 7% and operating income rose 22% for a record third quarter.
  • Third quarter operating income as a percent of sales rose to 14.1% compared with 12.4% for the same period in 2012.
  • The Engineered Infrastructure Products and Utilities Segments made the greatest contributions to the quarterly operating income improvement.
  • A decrease in the U.K. tax rate required a reduction in deferred tax assets and an increase in third quarter tax expense. This lowered net earnings by $8.3 million, or $0.31 in fully diluted earnings per share. As a result, reported diluted earnings per share were $2.10 and adjusted for the non-cash deferred tax asset reduction, diluted earnings per share were $2.41.

Valmont Industries has recorded strong revenue and EPS and dividend growth, and considering its compelling valuation metrics and its good earnings growth prospects, VMI stock can move higher. Furthermore, the growing dividend represents an income.

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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.

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 dividend 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 very high at 40.49%, while the return of the S&P 500 index during the same period was at 21.19%.

The difference between the dividend screen to the benchmark was even more noticeable in the 15 years back-test. The 15-year average annual return of the screen was very high at 20.68%, while the average annual return of the S&P 500 index during the same period was only 2.36%. The maximum drawdown of the screen was at 56.09%, 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: A Winning Dividend Portfolio According To Graham Principles