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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 (see the right hand column for a link to the spreadsheet).

Like many of the screens, strategies, and portfolios I track and prefer, this strategy takes a small number of historically relevant ideas, to create a simple, yet powerful action plan for the individual investor. As I have 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.

This portfolio attempts to capture the best high yield, low payout stocks with a history of raising dividends. There are numerous ways to gauge the “best” high yield/low payout stocks. The list 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

The Dividend Champions are the starting point and we begin by ranking the top third highest yielding champions. With the remaining high yielding stocks, we will eliminate 50% with the highest payout ratio. The remaining stocks are assigned a rank based on the ratio of their dividend yield to payout ratio (the same as a trailing earnings/price ratio, or the inverse of the trailing P/E ratio). This month we eliminated the requirement stocks have projected forward earnings – the requirement has rarely come to use since the portfolio’s inception and it relies on analyst’s projections.

The top 10 stocks based on this ratio 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 12 (to limit turnover) and are replaced with the next highest rated stock.

For May we sold MGE Energy (NASDAQ:MGEE) and PepsiCo (NYSE:PEP). MGE was sold at a loss of 2.41% (excluding dividends) and PEP was essentially flat since its purchase last month. The proceeds of these two transactions were used to purchase Chevron (NYSE:CVX) and UGI Corp (NYSE:UGI) at Friday’s closing price.

Last month’s Dividend Champion Portfolio update stated “The technical analyst in me has seen momentum in US equities slow the past few weeks. This particular portfolio has returned over 27% since inception but now may be a time to temper expectations.”

This still appears to be the case, so additional hedging or diversification techniques could reduce risk at this juncture. The High Yield Dividend Champion Portfolio was designed to be fully invested at all times regardless of market conditions. However, as part of a larger portfolio there may be additional steps an investor can take to reduce risk and diversify strategies. For example, using Born To Sell we can explore potential covered call opportunities on stocks in the portfolio. The CVX June $105 calls had a last bid of $1.74 and the June $110 calls had a last bid of $.38.

The equity curve of the portfolio is plotted below and since inception it is up over 27%. All discussions of returns are strictly hypothetical and exclude commissions and taxes.

The top 18 rated stocks for the purposes of this portfolio’s criteria are listed below:
Company Symbol Yield Payout Ratio Yield/Payout
Chevron Corp. CVX 3.38 26.79 0.126
Community Trust Banc. CTBI 3.88 46.10 0.084
Tompkins Financial Corp. TMP 3.80 46.60 0.082
Mercury General Corp. MCY 5.40 70.11 0.077
Eagle Financial Services OTCQB:EFSI 3.42 48.98 0.070
Sysco Corp. SYY 3.74 55.38 0.067
Universal Corp. UVV 4.28 64.90 0.066
UGI Corp. UGI 3.70 59.02 0.063
Nucor Corp. NUE 3.72 60.83 0.061
Questar Corp. STR 3.29 54.62 0.060
Sonoco Products Co. SON 3.62 60.30 0.060
Consolidated Edison ED 4.07 67.98 0.060
Clorox Company CLX 3.42 59.26 0.058
MGE Energy Inc. MGEE 3.35 57.97 0.058
Johnson & Johnson JNJ 3.75 67.03 0.056
Kimberly-Clark Corp. KMB 3.77 68.68 0.055
Procter & Gamble Co. PG 3.53 66.12 0.053
California Water Service CWT 3.48 70.00 0.050
Source: High Yield Dividend Champion Portfolio For May