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One of the basic and most important tenets of dividend investing is to seek stocks with a history of increasing dividends. Ideally, such stocks would also have a high dividend to reward investors for holding the stock. Starting with this basic premise, I used stockscreen123 to generate a list of high yield, dividend growth stocks which meet additional fundamental factors.

I began by looking for stocks yielding at least 3% with a 1, 3, and 5 year annual dividend growth rate of at least 5%. The goal is to find stocks which pay a relatively "high" yield--given that 5 year Treasuries yield near 2%--with a recent history of increasing the dividend.

Next, I sought stocks with a reported price to earnings ratio below their industry median The rationale for using a P/E below the industry median is that different industries may have different average P/E ratios. For example, slower growing utility companies may generally have a lower P/E than technology companies. Forward P/E ratios were not used in this screen because they are based on analyst's projections, which can often prove inaccurate. However, projecting a company's future earnings prospects is essential in any investor's due diligence process and can be difficult to capture in quantitative screens. Thus, reading conference call transcripts, looking for recent earning surprises, and analyzing a company's propensity for beating its own earnings guidance (if provided) are just a few ways to research beyond a screen.

Since dividends are sustained through earnings, the next criteria used was earnings growth - a 5 year annual earnings growth of at least 8% and earnings growth over the past 12 months of at least 10%. A company with a history of earnings growth could be more likely to sustain earnings growth in the future and thus sustain dividend increases.

In addition to earnings growth, a payout ratio below 50% was required. Payout ratio measures the percentage of dividends per share to earnings per share. The higher the ratio, the more earnings are being paid out as dividends. Thus, the lower the ratio, the more likely a dividend could be sustained even if earnings suffer a temporary setback.

Finally, a high return on equity was required -- 10 % annually over the past 5 years and 10% over the past 12 months. Return on equity can be a useful measure of management's effectiveness. It is the ratio of net income to shareholder equity, the higher the ratio the more profits a company earns per dollar of equity capital.

Inputing these parameters in stockscreen123 results in the 5 stocks below (ADRs were excluded):

Ticker

Name

SS123 Rank

Yield

Div% ChgA

Div3YC gr%

Div5YC Gr%

PayRatio TTM

(NASDAQ:STRA)

Strayer Education, Inc.

94.8

3.25

38.04

28.52

40.57

32.78

(NYSE:SXL)

Sunoco Logistics Partners L.P

94.32

5.46

15.19

10.29

12.73

48.81

(NYSE:NJR)

New Jersey Resources Corporat

82.94

3.36

9.68

10.43

8.45

47.85

(NYSE:NEE)

NextEra Energy, Inc.

74.48

3.68

6.18

8.01

7.77

40.17

(NYSE:MCD)

McDonald's Corporation

59.4

3.25

26.15

27.03

30.1

47.91

Many of our articles focus on momentum strategies including a high yield stock momentum strategy. Thus, it is helpful to focus on one stock in particular on the list, STRA, since it has struggled mightily of late and its negative momentum raised an immediate alarm, especially for someone who prefers to find stocks with positive price momentum. It has lost over -47% in the past 6 months. The chart below courtesy of Finviz shows just how ugly things have gotten for the adult education provider:

(Click to enlarge)

The entire education sector has struggled over the past several months as the US government has cracked down on the industry, which has been accused of misrepresenting enrollment numbers, churning out poorly educated students with loads of debt and no ability to repay. Many companies within the industry recently sued to overturn many of these new government reforms, but the cloud of uncertainty over the entire industry and future earnings may lead risk-adverse income investors to avoid STRA or the industry as a whole.

Another stock on the list, MCD, has recently seen profits and revenue increase. However, increasing commodity costs will force the fast food chain to raise prices and could have an impact on profit margins and earnings. The challenge for dividend investors interested in MCD is to monitor upcoming quarterly earnings reports for the impact higher costs have on earnings and the overall ability of the company to continue to raise dividends at its recent rate. Another strategy would be to hedge any position in MCD with an ETF, such as DBA or XLE, that profits from higher agricultural or commodity prices.

This is an example of the additional due diligence one should perform before investing in a stock based on a quantitative screen. However, I believe the parameters used above or variations using the same methodology can uncover potential dividend stocks worthy of consideration.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Source: 5 High Yield Dividend Growth Stocks