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In December 2010, I created a screen / hypothetical portfolio called the "High Yield Dividend Champion Portfolio." The screen is tracked publicly as a continuous hypothetical portfolio with a starting balance of $100,000 on Scott's Investments.

The High Yield Dividend Champion Portfolio uses a small number of historically relevant ideas to create a simple, yet powerful investment plan. As I previously detailed, "Some studies have shown that the highest yielding, low payout stocks perform better over time than stocks with higher payouts and lower yields." The High Yield Dividend Champion Portfolio attempts to capture the best high yield, low payout stocks with a history of raising dividends. There are numerous ways to rank high yield/low payout stocks. The screening process for this portfolio starts with the "Dividend Champions" as compiled by DRIP Investing. The list is comprised of stocks that have increased their dividend payout for at least 25 consecutive years.

To date, the portfolio is up over 74%. I mentioned in the 2013 year in review that valuation of high yield stocks was a concern (see World Beta and O'Shaughnessy). I do not know what 2014 will bring, but I have lowered my expectations for future returns of U.S. equities and high yield stocks.

There are a number of ways to filter high yield stocks to avoid those susceptible to a "crash". The High Yield Dividend Champion portfolio starts with the Dividend Champion list, comprised of quality stocks that have sustained dividend growth over the past 25 years. In addition, the payout ratio rank and dividend growth rank filter stocks which may have unsustainable payouts or low dividend growth.

For 2014 I am adding a valuation filter to the screen. We still begin with the Dividend Champion list, which is first sorted by yield and the lowest 50% yielding stocks are eliminated. Eliminating the lowest yielding stocks ensures only stocks with a relatively "high" yield make the portfolio.

The remaining stocks are then assigned a rank based on their yield (the higher the yield the higher the rank), payout ratio (the lower the payout ratio the higher the rank), 3 year dividend growth rate, and price-earnings (P/E) ratio. Extra weight is given to yield and payout ratio rankings. The 5/10 year Dividend Acceleration / Deceleration metric will no longer be used (5-year average increase divided by 10-year average increase)

The top 10 stocks based on the new ranking system make the portfolio. Stocks will be sold at the re-balance date (generally around the 5th of the month) when they drop out of the top 15 (to limit turnover) and are replaced with the next highest rated stock.

There is turnover in two positions this month. WGL Holdings Inc. (NYSE:WGL) is being sold at a capital gain of 2.49% and original purchase date of 12/6/12. Northwest Natural Gas (NYSE:NWN) is being sold at a capital loss of 4.66% and original purchase date of 4/5/13. Proceeds from the sales will be used to purchase McDonald's (NYSE:MCD) and Tompkins Financial (NYSEMKT:TMP).

The top 15 stocks based on my ranking methodology are below and displayed in order of their overall ranking (figures are December month-end):

NameSymbolYieldPayout3-yrP/E
Chevron Corp.CVX3.2032.7332211.1515210.22
Helmerich & Payne Inc.HP2.9737.5375480.7896512.62
Eagle Financial ServicesOTCQB:EFSI3.3837.438423.27332711.08
Universal Corp.UVV3.7439.921722.0839310.68
McDonald's Corp.MCD3.3458.4837511.3479117.51
Tompkins Financial Corp.TMP3.1148.780495.03211515.67
Altria Group Inc.MO5.00758.22511415.00
ExxonMobil Corp.XOM2.4932.9411812.2350813.23
Target Corp.TGT2.7246.112623.4409516.96
Cincinnati FinancialCINF3.2147.191011.19491814.71
American States WaterAWR2.8251.5923613.4845518.30
UGI Corp.UGI2.7347.083337.07956317.28
Community Trust Banc.CTBI2.8342.524921.49275715.00
Old Republic InternationalORI4.1763.157891.42876415.15
Piedmont Natural GasPNY3.7466.666673.48102217.83
Leggett & Platt Inc. (tied with PNY)LEG3.8868.571433.67296517.68

The current portfolio is below:

PositionSharesPurchase PricePurchase Date
CVX120106.4512/6/2012
MCD16796.541/3/2014
HP28065.487/5/2013
UVV29445.554/5/2012
UGI43142.498/5/2013
LEG57731.728/5/2013
XOM19689.014/5/2013
MO39534.243/5/2013
AWR67427.257/5/2013
TMP32150.31/3/2014

Disclosure: No positions

Disclaimer: Stock Loon LLC, Scott's Investments and its author is not a financial adviser. Stock Loon LLC, Scott's Investments and its author does not offer recommendations or personal investment advice to any specific person for any particular purpose. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of www.scottsinvestments.com

Source: January High Yield Dividend Champion