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Although the decline of the S&P SmallCap 600 index year to date has been worse than that of the S&P MidCap 400 index and the S&P 500 index, it has given higher return during one year period and three and five years period, as shown in the table below.

A Ranking system sorts stocks from best to worst based on a set of weighted factors. Portfolio123 has a powerful ranking system which allows the user to create complex formulas according to many different criteria. They also have highly useful several groups of pre-built ranking systems, I used one of them the "Balanced4" in this article.

The "Balanced4" ranking system is quite complex, and it is taking into account many factors like; EPS consistency, technical analysis, valuation, profitability ratios and dividend information, as shown in the Portfolio123's chart below.

In order to find out how such a ranking formula would have performed during the last 15 years, I ran a back-test, which is available by the Portfolio123's screener. For the back-test, I took all the 7,014 stocks in the Portfolio123's database.

The back-test results are shown in the chart below. For the back-test, I divided the 7,014 companies into fifty groups according to their ranking. The chart clearly shows that the average annual return has a very significant positive correlation to the "Balanced4" rank. The highest ranked group with the ranking score of 98-100, which is shown by the dark blue column in the chart, has given by far the best return, an average annual return of about 23%, while the average annual return of the S&P 500 index during the same period was about 2.5% (the red column at the left part of the chart). Also, the second and the third group (scored: 96-98 and 94-96) have given superior returns. This brings me to the conclusion that the ranking system is very useful.

After running the "Balanced4" ranking system on the companies which are included in the S&P SmallCap 600 index and pay a dividend with a higher than 1% yield, on February 7, before the market open, I discovered the ten best dividend stocks, which are shown in the charts below. In this article, I describe the first stock of the list HCI Group, Inc. (NYSE:HCI).

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HCI Group, Inc.

HCI Group, Inc. owns subsidiaries engaged in diverse, yet complementary business activities, including homeowners' insurance, reinsurance, real estate and information technology services. The company's largest subsidiary, Homeowners Choice Property & Casualty Insurance Company, Inc., is a leading provider of property and casualty insurance in the state of Florida.

On November 5, HCI Group reported its third-quarter financial results, which beat EPS expectations by $0.35. The company reported that income available to common stockholders in the third quarter of 2013 totaled $13.4 million or $1.13 diluted earnings per common share, compared with $2.8 million or $0.27 diluted earnings per common share in the third quarter of 2012.

Now let's look at the numbers, HCI has recorded exceptionally strong revenue and EPS growth during the last five years. The average annual sales growth for the past five years was extremely high at 84.30%, and the average annual EPS growth for the past five years was unusually high at 59.80%, no other stock among S&P 1500 financial stocks has recorded combined stronger results. HCI is generating a lot of cash; its ttm price to free cash flow of 4.24 is among the lowest of all S&P 600 financial stocks. Many investors prefer using free cash flow instead of net income to measure a company's financial performance because free cash flow is more difficult to manipulate. Free cash flow is the operating cash flow minus capital expenditure. The HCI stock is trading now 25.2% below its 52-week high, and has 25% upside potential based on the consensus mean target price of $50.

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Chart: finviz.com

On January 23, Homeowners Choice Property & Casualty Insurance Company, a wholly-owned insurance subsidiary of HCI Group, Inc., announced at a press conference it is the first admitted homeowners insurance carrier to provide flood insurance in the state of Florida since the advent of the Biggert-Waters Flood Reform Act of 2012. On that occasion, Homeowners Choice's executive chairman, Paresh Patel said:

Our policyholders were our top priority as we made the decision to offer flood insurance. We want to try to help our customers who were hit hardest by hefty rate increases under the National Flood Insurance Program.

HCI's management decision frightened investors and as a result, HCI stock fell 10.58% the next trading day. In my opinion, the market reaction was exaggerated, and the retreat in the stock price opens an excellent opportunity to start a long-term investment in a promising company.

Conclusion

HCI has recorded exceptionally strong revenue and EPS growth, the highest among all S&P 1500 financial stocks, and it has compelling valuation metrics. HCI is generating strong free cash flows and returns value to its shareholders by stock buyback and by dividend payments, current yield is at 2.74%, and the payout ratio is only 16%.

All these factors lead me to the conclusion that HCI stock is a smart long-term investment.

Source: Best Small-Cap Dividend Stock According To A Winning Ranking System