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This article is part of a regular series in which I focus on the US Dividend Champions, a list compiled and tracked at DRIP Investing. The list is comprised of stocks which have increased their dividend payout for at least 25 consecutive years. As I have shown on my site, there are several ways to invest and this strategy is but just one in what I believe should be a "basket" of strategies from which to allocate a portfolio.

However, I consider the method detailed below, which combines Dividend Champions with 2 simple ranking tools, one of the most effective ways to filter for high quality dividend paying stocks.

Some studies have shown that the, highest yielding, low payout stocks perform better over time than stocks with higher payouts and lower yields. I originally cited a Credit Suisse study on the S&P 500 here. To summarize, they found that from 1990-2006:

Below [chart availabe in paper], we show cumulative return obtained in our back test of each dividend yield and payout ratio portfolios. We find that companies with low payout ratios tended to perform better than companies with high or negative payout ratios. Portfolios of companies with high dividend yields and low payout ratios have the best returns.

Clearly, past performance is not a guarantee of future returns. The study cited above also did not focus just on Dividend Champions but rather the entire S&P 500. However, if an investor is seeking to narrow the list of potential candidates to a more manageable list, I think the Dividend Champions list is a great starting point.

If we were to focus on the entire universe of stocks when searching for yield and low payout ratios, we may find several qualifying stocks that have not or will not continue to increase or even pay dividends. The stocks on the Dividend Champions list have the added advantage of a strong tradition of raising dividends. By applying the same principles which have been successful on larger and a less selective universe of stocks to Dividend Champions, I believe we can find potential investments.

I ran this screen last month and many of the same names remain. One new addition to this month's list is McDonalds (MCD), replacing Kimberly-Clark (KMB) from last month's list. However, KMB is ranked twelfth this month so it is more a testament of McDonald's recent price decline elevating its dividend to a point for inclusion on the list then of any material change in KMB's metrics.

By simplifying our search for equity income and looking for stocks with a history of increasing dividends and paying investors a healthy yield without eating up a large percentage of earnings to do so, we can find potential winners with staying power in a portfolio.

The method used to generate this list was to first take the top third of Dividend Champions based on yield and then sort this list based on the top third with the lowest payout ratio. This month's list has 98 stocks, so the top 33 yielding stocks was my starting point. I then ranked the remaining 33 based on payout ratio. The top 11 results are below:

Finviz was used as the data source for this screen, and then the stocks were screened based on yield and payout on a real-time basis. However, another option is to use the free spreadsheet provided by DRIP, updated on 12/31/10.

Ticker

Company

Retirement Portfolios

Forward P/E

Div. Yield

Payout Ratio

200-Day SMA

UVV

Universal

Here

8.67

4.82%

33.77%

-6.30%

JNJ

Johnson & Johnson

Here

12.67

3.41%

41.71%

4.17%

T

AT&T, Inc.

Here

11.9

5.76%

47.03%

12.80%

MCD

McDonald's

Here

14.8

3.28%

47.91%

3.37%

SYY

Sysco Corp.

Here

13.92

3.51%

51.13%

1.12%

SON

Sonoco Products

Here

13.37

3.23%

51.72%

7.80%

CINF

Cincinnati Financial

Here

21.95

4.99%

52.02%

14.37%

CLX

Clorox

Here

13.36

3.57%

55.81%

-3.49%

ABT

Abbott Laboratories

Here

10.36

3.65%

56.29%

-1.95%

PNY

Piedmont Natural Gas

Here

16.37

4.00%

56.38%

2.93%

MGEE

MGE Energy

Here

15

3.51%

57.84%

13.24%

Disclosure: No positions

Source: 11 High Yield Stocks With Staying Power