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I have created a good-yielding blue chip stocks portfolio that can outperform the market by a big margin. For this portfolio, I have searched for companies that are included in the S&P 500 index that pay rich dividends with a low payout ratio and high dividend growth over the past five years. Those stocks also would 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 does not trade over-the-counter (OTC).
  2. Dividend yield is greater than 2%.
  3. The annual rate of dividend growth over the past five years is greater than 5%.
  4. The payout ratio is less than 75%.
  5. Forward P/E is less than 15.
  6. The PEG ratio is less than 1.50.
  7. Total debt to equity is less than 0.40.
  8. The ten 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 Yahoo Finance, Portfolio123 and finviz.com.

After running this screen on November 06, 2013, before the market open, I discovered the following ten stocks:


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


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Valero Energy Corporation (NYSE:VLO)

Valero Energy Corporation operates as an independent petroleum refining and marketing company.


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Source: company presentation

Valero Energy Corporation has a low debt (total debt to equity is 0.36), and it has a very low trailing P/E of 8.24 and a very low forward P/E of 9.28. The price-to-sales ratio is very low at 0.16, and the price to free cash flow is also very low at 10.64. The average annual earnings growth estimates for the next five years is at 3.63%. The forward annual dividend yield is at 2.17%, and the payout ratio is only 14.8%. The annual rate of dividend growth over the past five years was at 10.37%.

The VLO stock price is 7.41% above its 20-day simple moving average, 13.45% above its 50-day simple moving average and 10.41% above its 200-day simple moving average. That indicates a short-term, a mid-term and a long-term uptrend.

Valero Energy Corporation has recorded strong revenue and EPS growth during the last three years, as shown in the table below.

Most of Valero Energy's stock valuation parameters have been much 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 charts below emphasize the advantage of North American refiners due to the local growth of oil and natural gas production.


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Source: company presentation

Valero is returning more cash to stockholders, as shown in the chart below.


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On October 29, Valero Energy reported its third-quarter financial results, which beat EPS expectations by $0.16 and beat on revenues. The company reported net income attributable to Valero stockholders of $312 million, or $0.57 per share, for the third quarter of 2013 compared to net income attributable to Valero stockholders of $674 million, or $1.21 per share, for the third quarter of 2012. The third quarter 2012 results included a noncash asset impairment loss of $341 million after taxes, or $0.62 per share, and severance expense of $41 million after taxes, or $0.07 per share, primarily related to the Aruba refinery. Excluding these items, Valero reported third quarter 2012 net income attributable to Valero stockholders of $1.1 billion, or $1.90 per share.

Valero Energy has compelling valuation metrics and considering the fact that the stock is in an uptrend, VLO stock still has room to go up. Furthermore, the rich growing 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

The Gap, Inc. (NYSE:GPS)

The Gap, Inc. operates as an apparel retail company.

The Gap has a low debt (total debt to equity is 0.36), and it has a low trailing P/E of 13.85 and a low forward P/E of 12.49. The PEG ratio is low at 1.04, and the average annual earnings growth estimates for the next five years is quite high at 13.35%. The forward annual dividend yield is at 2.13%, and the payout ratio is only 20%. The annual rate of dividend growth over the past five years was at 12%.

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

The Gap's margins and return on capital have been much better than its industry median and the sector median, as shown in the tables below.


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Most of The Gap '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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The Gap will report its latest quarterly financial results on November 30. GPS is expected to post a profit of $0.66 a share, a 5% rise from the company's actual earnings for the same quarter a year ago.

The Gap has recorded strong revenue, EPS and dividend growth, and considering its compelling valuation metrics and its good earnings growth prospects, GPS stock can move higher. Furthermore, the rich growing dividend represents a nice income.


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Chart: finviz.com

AFLAC Inc (NYSE:AFL)

Aflac Incorporated, through its subsidiary, American Family Life Assurance Company of Columbus, provides supplemental health and life insurance products.

Aflac Incorporated has a low debt (total debt to equity is only 0.34), and it has a very low trailing P/E of 3.37 and a very low forward P/E of 10.10. The price-to-sales is very low at 0.98, and the average annual earnings growth estimates for the next five years is at 5.75%. The forward annual dividend yield is at 2.30%, and the payout ratio is only 20.6%. The annual rate of dividend growth over the past three years was at 7.70% and over the past five years was at 7.83%.

Aflac 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.

Aflac's return on capital has been much better than its industry median, sector median and the S&P 500 median, as shown in the tables below.


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Most of Aflac'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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On October 29, Aflac reported its third-quarter financial results, which was in-line on EPS and in-line on revenues. Reflecting the weaker yen/dollar exchange rate, total revenues fell 14.0% to $5.9 billion during the third quarter of 2013, compared with $6.8 billion in the third quarter of 2012. Net earnings were $702 million, or $1.50 per diluted share, compared with $1.0 billion, or $2.16 per share, a year ago.

Aflac has recorded very strong revenue, EPS and dividend growth, and considering its compelling valuation metrics and its solid earnings growth prospects, AFL stock can move higher. Furthermore, the rich growing dividend represents a nice income.

Since a significant portion of Aflac's business is in Japan, where the functional currency is the yen, the impact from translating yen into dollars might reduce Aflac's operating earnings, in case of decrease in the exchange rate of the yen.


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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 years back-test


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Fifteen years 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.

One-year return of the screen was very high at 42.28%, while the return of the S&P 500 index during the same period was at 24.41%.

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 very high at 12.24%, while the average annual return of the S&P 500 index during the same period was only 2.46%. The maximum drawdown of the screen was at 46.42%, 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 Blue Chips Portfolio That Can Outperform By A Big Margin