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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 five years. Furthermore, in order to decrease the maximum expected drawdown to a lower level than that of the benchmark I had to be satisfied with a bit lower return, but still much better than the benchmark.

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 five years is greater than 5%.
  7. Total debt to equity is less than 0.40.
  8. Average annual earnings growth estimates for the next five years is greater than 5%.
  9. The twenty stocks with the lowest payout ratio among all the stocks that complied with the first eight 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 Yahoo Finance, Portfolio123 and finviz.com.

After running this screen on October 29, 2013, before the market open, I discovered the following twenty stocks:

Rank

Ticker

Name

Last Price

Market Cap $million

Industry

1

(NYSE:VLO)

Valero Energy Corp

39.44

21,380

Oil, Gas & Consumable Fuels

2

(NYSE:AFL)

AFLAC Inc

66.30

30,818

Insurance

3

(NYSE:DK)

Delek US Holdings Inc

25.59

1,511

Oil, Gas & Consumable Fuels

4

(NYSE:GPS)

Gap Inc.

36.66

17,157

Specialty Retail

5

(NYSE:ACE)

ACE Ltd

96.14

32,694

Insurance

6

(NYSE:MOS)

Mosaic Company

45.94

19,562

Chemicals

7

(NYSE:HMN)

Horace Mann Educators Corporation

28.49

1,143

Insurance

8

(NYSE:TRV)

Travelers Companies Inc

86.63

31,542

Insurance

9

(NYSE:AXS)

AXIS Capital Holdings Ltd

46.83

5,226

Insurance

10

(NYSE:GLW)

Corning Inc

17.35

25,331

Electronic Equipment, Instruments & Components

11

(NYSE:FL)

Foot Locker Inc.

34.20

5,078

Specialty Retail

12

(NYSE:BVN)

Compania De Minas Buenaventura SA Buena

14.41

3,663

Metals & Mining

13

(NASDAQ:QCOM)

QUALCOMM Inc.

68.27

117,561

Communications Equipment

14

(NYSE:CNA)

CNA Financial Corp

39.69

10,704

Insurance

15

(NYSE:XOM)

Exxon Mobil Corp

87.97

387,244

Oil, Gas & Consumable Fuels

16

(NYSE:PRE)

PartnerRe Ltd.

93.60

5,085

Insurance

17

(NYSE:COH)

Coach Inc.

49.89

14,064

Textiles, Apparel & Luxury Goods

18

(NASDAQ:BANF)

BancFirst Corp

56.38

863

Commercial Banks

19

(NYSE:ESV)

ENSCO Plc

57.02

13,317

Energy Equipment & Services

20

(NASDAQ:MSFT)

Microsoft Corp

35.73

298,203

Software

The table below presents the dividend yield, the payout ratio, the annual rate of dividend growth over the past five years, the total debt to equity ratio and the earnings growth estimates for the next five years, for the twenty companies.


(Click to enlarge)

Delek US Holdings Inc

Delek US Holdings, Inc. operates as an integrated downstream energy company that operates in petroleum refining, logistics, and convenience store retailing businesses.

Delek US Holdings has a low debt (total debt to equity is only 0.30), and it has a very low trailing P/E of 5.45 and a low forward P/E of 13.81. The price-to-sales ratio is very low at 0.17, and the PEG ratio is at 1.38. The price to free cash flow for the trailing 12 months is very low at 12.00, and the average annual earnings growth estimates for the next five years is quite high at 10%. The forward annual dividend yield is at 2.34%, and the payout ratio is only 18.7%. The annual rate of dividend growth over the past five years was at 7.21%.

The DK stock price is 10.66% above its 20-day simple moving average and 9.57% above its 50-day simple moving average. That indicates a short-term and a mid-term uptrend.

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

Delek US Holdings' return on capital has 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)

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


(Click to enlarge)

Source: Portfolio123

Delek US Holdings will report its latest quarterly financial results on November 05. DK is expected to post a profit of $0.06 a share.

On August 07, Delek US reported its second-quarter financial results. Delek US reported net income of $46.6 million, or $0.78 per diluted share, versus net income of $67.8 million, or $1.15 per diluted share in the second quarter 2012. Lower earnings were primarily due to the refining segment, which faced less favorable market conditions in the second quarter 2013 compared to the prior-year-period, as a decline in the 5-3-2 Gulf Coast crack spread reduced margins. In addition, the differential between WTI Midland and WTI Cushing narrowed on a year-over-year basis.

Delek US Holdings has recorded strong revenue, EPS and dividend growth, and considering its compelling valuation metrics and its good earnings growth prospects, DK 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.


(Click to enlarge)

Chart: finviz.com

ACE Limited

ACE Limited, through its subsidiaries, provides a range of insurance and reinsurance products to insured worldwide. The company was founded in 1985 and is headquartered in Zurich, Switzerland.

ACE Limited has a very low debt (total debt to equity is only 0.21), and it has a very low trailing P/E of 10.14 and a very low forward P/E of 11.55. The price to free cash flow is very low at 8.71, and the average annual earnings growth estimates for the next five years is at 6.92%. The forward annual dividend yield is at 2.12%, and the payout ratio is only 20.5%. The annual rate of dividend growth over the past three years was very high at 17.69% and over the past five years was also high at 12.85%.

The ACE stock price is 1.34% above its 20-day simple moving average, 3.61% above its 50-day simple moving average and 7.35% above its 200-day simple moving average. That indicates a short-term, a mid-term and a long-term uptrend.

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

On October 22, ACE Limited reported its latest quarter financial results, which beat EPS expectations by $0.26. The company reported net income for the quarter ended September 30, 2013, of $2.66 per share, compared with $1.86 per share for the same quarter last year. Operating income was $2.49 per share, compared with $2.01 per share for the same quarter last year. Book value and tangible book value per share increased 3.4% and 3.9%, respectively, from June 30, 2013. Book value and tangible book value per share now stand at $82.98 and $66.91, respectively. Operating return on equity for the quarter was 13.0%. The property and casualty combined ratio for the quarter was 86.5%.

ACE Limited has recorded revenue, EPS and dividend growth, and considering its cheap valuation metrics, its solid earnings growth prospects, and the fact that the stock is in an uptrend, ACE stock can move higher. Furthermore, the rich growing dividend represents a nice income.


(Click to enlarge)

Chart: finviz.com

Travelers Companies Inc.

The Travelers Companies, Inc., through its subsidiaries, provides various commercial and personal property and casualty insurance products and services to businesses, government units, associations, and individuals primarily in the United States.

The Travelers has a very low debt (total debt to equity is only 0.26), and it has a very low trailing P/E of 11.25 and a very low forward P/E of 10.97. The price to free cash flow for the trailing 12 months is low at 13.44, and the average annual earnings growth estimates for the next five years is at 9.24%. The forward annual dividend yield is at 2.31%, and the payout ratio is only 24.2%. The annual rate of dividend growth over the past five years was quite high at 9.64%.

The TRV stock price is 2.32% above its 20-day simple moving average, 4.37% above its 50-day simple moving average and 6.37% above its 200-day simple moving average. That indicates a short-term, a mid-term and a long-term uptrend.

On October 22, The Travelers reported its third-quarter financial results, which beat EPS expectations by $0.30 and was in-line on revenues.

Third-Quarter Highlights

  • Record Quarterly Operating Income per Diluted Share of $2.35, Up 6% from Prior Year Quarter.
  • Return on Equity and Operating Return on Equity of 13.9% and 15.2%, Respectively.
  • Strong net and operating income of $864 million and $883 million, respectively, generally consistent with the prior year quarter.
  • Continued improvement in underlying underwriting margins.
  • Written rate gains continued to exceed expected loss cost trends in all segments.
  • Total capital returned to shareholders of $985 million in the quarter, including $800 million in share repurchases. Year-to-date total capital returned to shareholders of $1.952 billion.
  • Board of Directors authorizes an additional $5.0 billion of share repurchases.
  • Increase in book value per share of 1% to $68.15 and increase in adjusted book value per share of 8% to $63.87 from year-end 2012.

The Travelers has compelling valuation metrics and good earnings growth prospects, and considering its good latest quarter financial results and the fact that the stock is in an uptrend, TRV stock can move higher. Furthermore, the rich growing dividend represents a nice income.


(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 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-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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(Click to enlarge)

One year back-test


(Click to enlarge)

Five years back-test


(Click to enlarge)

Fifteen years back-test


(Click to enlarge)

Summary

The good-yielding 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 40.34%, while the return of the S&P 500 index during the same period was at 24.62%.

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 13.55%, while the average annual return of the S&P 500 index during the same period was only 2.45%. The maximum drawdown of the screen was at 44.80%, 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, Lower Risk Dividend Portfolio That Has Outperformed The Market