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The Magic Formula was used to pick dividend paying stocks without detracting from its performance in a prior article. Since the Magic Formula does not seem to suffer from limiting picks to dividend-paying stocks, this screening method was used to create a current list of the best dividend stocks to buy now in October 2012.

This strategy is designed for income investors who are concerned that dividend-yielding stocks are becoming too pricey. It combines a screen for dividend income with Greenblatt's screen for the best stocks trading at the cheapest values.

What Is The Magic Formula?

Joel Greenblatt has reported enviable annual 30.8% returns for his "Magic Formula" in his book, The Little Book that Beats the Market. Since publishing his book, his strategy has performed well, though many analysts who have followed the "Magic Formula" have not seen 30.8% annual returns, but have seen outperformance from this strategy. His results are particularly interesting because his picks are not subjective: they are based on a simple ranking of earnings yield (EBIT/EV) and return on capital.

Magic Formula stocks have historically outperformed the market with a total portfolio, which is a blend of value and growth with a beta of roughly 1 (1.05). This blended profile of Magic Formula picks lends itself to do-it-yourself investors as a core holding strategy. Moreover, since many of these picks have dividend yields, they can be used to create an income portfolio.

Screening For Magic Formula Dividend Stocks

The following methods were used to extract appropriate dividend-yielding stocks from Greenblatt's Magic Formula results:

Stocks were selected using the Magic Formula methodology. Each of these stocks is one of a top-50 selection with $50 million, $2 billion, or $10 billion market capitalization minimums.

Stocks were screened for dividend yield. Of these Magic Formula picks, stocks with no dividend yield or which had a dividend yield less than the 10-year treasury yield (currently 1.63%) were removed.

Stocks were screened for payout ratio. Only stocks with payout ratios under 60% were retained. Dividend payouts under 60% are considered reasonable and sustainable.

These firms hail from many different industries and have an average dividend yield that is about twice the 10-year treasury yield:

Ticker

Company

Industry

Div Yield

Payout Ratio

BA

Boeing

Aerospace/Defense

2.51%

29.7%

CA

CA Technologies

Application Software

3.93%

30.5%

CAT

Caterpillar

Conglomerates

2.43%

20.2%

CL

Colgate-Palmolive

Personal Products

2.30%

46.1%

CMCSA

Comcast

CATV Systems

1.84%

30.5%

COP

ConocoPhillips

Major Integrated Oil & Gas

4.60%

49.7%

CSCO

Cisco Systems

Networking & Communication

2.94%

18.7%

CVX

Chevron

Major Integrated Oil & Gas

3.07%

24.5%

DLX

Deluxe

Business Services

3.24%

31.4%

GD

General Dynamics

Aerospace/Defense

3.03%

28.3%

GME

GameStop

Electronics Stores

4.71%

12.6%

HD

The Home Depot

Home Improvement Stores

1.92%

40.0%

INTC

Intel

Semiconductor - Broad Line

3.95%

34.1%

JCOM

j2 Global

Internet Software & Services

2.68%

34.4%

KRFT

Kraft Foods

Food - Major Diversified

2.73%

57.2%

KLAC

KLA-Tencor

Semiconductor Supplies

3.38%

30.9%

KO

The Coca-Cola Company

Beverages - Soft Drinks

2.66%

50.8%

KRO

Kronos Worldwide

Specialty Chemicals

4.06%

18.7%

LLY

Eli Lilly &

Drug Manufacturers - Major

4.12%

56.4%

MANT

ManTech International

Security Software & Services

3.50%

26.9%

MCD

McDonald's

Restaurants

3.35%

50.3%

MMM

3M

Conglomerates

2.53%

36.7%

MSFT

Microsoft

Application Software

3.12%

39.6%

NSU

Nevsun Resources Ltd.

Gold

2.14%

11.1%

NUS

Nu Skin Enterprises

Personal Products

1.98%

21.9%

OXY

Occidental Petroleum

Major Integrated Oil & Gas

2.50%

25.8%

PDLI

PDL BioPharma

Biotechnology

7.63%

52.8%

PEP

Pepsico

Beverages - Soft Drinks

3.04%

54.1%

QSII

Quality Systems

Healthcare Information Services

3.91%

57.3%

RTN

Raytheon

Aerospace/Defense

3.60%

31.9%

STRA

Strayer Education

Education & Training Services

6.03%

55.5%

STX

Seagate Technology PLC

Data Storage Devices

4.25%

12.8%

UNP

Union Pacific

Railroads

2.02%

29.2%

UPS

United Parcel Service

Air Delivery & Freight Services

3.17%

54.8%

USMO

USA Mobility

Wireless Communications

4.16%

48.6%

UTX

United Technologies

Conglomerates

2.73%

31.0%

VIAB

Viacom

CATV Systems

2.05%

24.6%

WMT

Wal-Mart Stores

Discount, Variety Stores

2.15%

31.9%

XLS

Exelis

Communication Equipment

3.93%

18.1%

XOM

Exxon Mobil

Major Integrated Oil & Gas

2.48%

20.9%

Average

3.26%

34.5%

Moreover, these stocks are reasonably priced:

Ticker

Company

P/E

P/S

P/B

BA

Boeing

12.13

0.69

9.07

CA

CA Technologies

12.98

2.49

2.17

CAT

Caterpillar

9.56

0.84

3.51

CL

Colgate-Palmolive

21.38

3.01

22.22

CMCSA

Comcast

20.33

1.59

1.98

COP

ConocoPhillips

11.08

1.08

1.52

CSCO

Cisco Systems

12.78

2.19

1.97

CVX

Chevron

8.73

0.93

1.77

DLX

Deluxe

9.77

1.06

4.35

GD

General Dynamics

9.84

0.73

1.74

GME

GameStop

9.04

0.29

0.95

HD

The Home Depot

21.63

1.27

5.18

INTC

Intel

9.64

2.09

2.34

JCOM

j2 Global

13.55

4.31

2.71

KRFT

Kraft Foods

21.05

1.39

2.08

KLAC

KLA-Tencor

10.63

2.48

2.38

KO

The Coca-Cola Company

20.31

3.64

5.36

KRO

Kronos Worldwide

4.59

0.82

1.62

LLY

Eli Lilly &

13.18

2.36

3.86

MANT

ManTech International

7.67

0.32

0.78

MCD

McDonald's

17.29

3.38

6.61

MMM

3M

15.24

2.18

3.93

MSFT

Microsoft

14.74

3.35

3.73

NSU

Nevsun Resources Ltd.

5.2

1.42

1.65

NUS

Nu Skin Enterprises

12.82

1.23

4.3

OXY

Occidental Petroleum

11.13

2.89

1.77

PDLI

PDL BioPharma

5.91

3.06

PEP

Pepsico

18.59

1.65

5.38

QSII

Quality Systems

14.66

2.37

3.47

RTN

Raytheon

9.67

0.75

2.14

STRA

Strayer Education

8.92

1.34

11.37

STX

Seagate Technology PLC

4.67

0.79

3.41

UNP

Union Pacific

15.33

2.73

2.94

UPS

United Parcel Service

17.82

1.28

9.05

USMO

USA Mobility

5.86

1.14

1.03

UTX

United Technologies

13.32

1.28

3.16

VIAB

Viacom

12.98

1.89

3.71

WMT

Wal-Mart Stores

15.59

0.54

3.55

XLS

Exelis

6.15

0.34

1.85

XOM

Exxon Mobil

9.64

0.85

2.6

Mean

12.39

1.70

3.93

Median*

12.46

1.37

2.94

Repurposing the Magic Formula for dividend investing created a compelling portfolio. It has a median holding price-to-earnings ratio of 12.46, and a price-to-sales ratio of 1.37. This is an attractively valued income portfolio.

*These price multiples should be averaged using a harmonic mean (ratios which are better when they are smaller usually should be averaged using the harmonic mean), but reporting the median value and algebraic mean is more straightforward for a general audience. The harmonic means were 10.41 for the P/E ratio, 1.09 for the P/S ratio, and 2.46 for the (P/B) ratio.

Disclaimer: This article was written to provide investor information and education, and should not be construed as investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing.

Source: Magic Formula Dividends For October