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This article is a follow-up on our previous article where we started identifying undervalued dividend stocks with high yield, high dividend growth, low payout in order to build and manage a core stock portfolio.
We focus on this type of stocks not only because we want to collect a growing and regular income stream, but also because many studies have pointed to the outperformance of such stocks over time.

Following the process detailed in the article, we started this dividend portfolio on January 6 with 9 positions in Aflac (AFL), Eaton Vance (EV), Illinois Tool Works (ITW), Conoco Philipps (COP), Harris (HRS), Hasbro (HAS), Intel (INTC), Lockheed Martin (LMT) and Strayer Education (STRA). In the last four weeks, these positions returned around 10.5% (+10.53% at the time of writing this friday morning), to be compared to a 5.17% increase in the S&P500 (SPY) over the same period. Note that this was achieved by a portfolio whose beta is around 1.17.

We use the DRIP List to run a screen each month sorting out stocks that both have yields above average, a payout ratio below average and that are growing their dividend at a rate above average. Based on this criteria, the screen with data updated as of January 31, 2012 suggests 9 potential new candidates for inclusion in the portfolio:

Company Symbol Industry Div. Yield Div. Gr. Rate Payout
Nucor NUE Steel & Iron 3.28 19.13 59.59
PepsiCo PEP Beverages/Snack Food 3.14 11.19 51.63
Nippon Telegraph & Tel NTT Telecommunications 3.28 19.28 33.70
Novartis NVS Drugs 4.33 18.31 55.36
Darden Restaurants DRI Restaurants 3.75 32.61 52.60
Greif GEF Packaging 3.47 17.06 45.28
Raytheon Company RTN Aerospace/Defense 3.58 54.12 32.58
Wisconsin Energy WEC Utility-Elec/Gas 3.53 17.21 52.86

Based on an analysis of earnings history and prospects and valuation metrics, we exclude Nucor (NUE), Greif (GEF) and Wisconsin Energy (WEC). Note that these decisions are not definitive as a company's prospects and valuation can change, sometimes over a relatively short period of time. For instance, we did not include NTT last month but are now opening a new position in the stock as we feel more confident the company will be able to maintain an 8% increase in earnings over the next years, which makes it attractively valued at current levels.

Although the dividend history of Raytheon (RTN) has not been irreprochable over the last few years, the company seems attractively valued and could have been included if we did not already have a position in Lockheed Martin.

We will therefore open 4 new positions (for 3% each) as of the close of this Friday February 4, 2012:

PepsiCo is arguably an "all inclusive stock". The firm has a wide moat, is consistently growing earnings, is fairly valued and is growing an already generous dividend at a solid pace, which it can do because of a payout ratio only around 50%.

Darden Restaurants is also offering good prospects. This addition also diversifies our sector exposure.

Novartis also meets all our criteria. The legal uncertainties surrounding one of its drugs is excessively depressing the stock price. This addition also gives us international exposure, as does NTT.

With these 13 positions, we will have around 40% of the portfolio invested. The remaining 60% cash share will allow us to jump on new opportunities as they arise. We track the performance of this portfolio on an ongoing basis on our website.

Source: Strong Dividend Stock Portfolio Update