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What are we looking for?

U.S. dividend stocks that also offer quality and growth.

Over the past few weeks, Craig McGee, senior consultant at Morningstar Canada, has provided us with a closer examination of some of Morningstar's proprietary stock indexes. Today, we're looking at the Morningstar U.S. Dividend Target 50 Index – a selection of 50 U.S. stocks that not only have high dividend yields, but score highly in a combination of other key factors that are indicative of a stock's underlying quality and potential.

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The index represents dividend-paying stocks that trade on a major U.S. stock exchange and score highest in a ranking system that combines dividend yield (33.3 per cent of the score), cash-flow-to-debt ratio (20 per cent), return on equity in the latest quarter (20 per cent), five-year earnings-per-share growth (13.3 per cent) and consensus earnings-per-share estimate revisions over the past 90 days (13.3 per cent).

The stocks are assigned letter grades for each category, and those are combined to come up with the list of the highest-graded stocks. Only stocks whose average daily trading volume is in the top one-third of the Morningstar CPMS database are eligible, and the index sets a maximum of five stocks in any single industry sector.

While the index is composed of the 50 highest-scoring stocks under this scoring system, we have included only the top 20 stocks in our list.

More about Morningstar

Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its investment research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market.

What did we find?

Mr. McGee said that if the index is back-tested to Dec. 31, 1993, using a strategy of selling any stock that falls outside of the top 40 per cent of the overall CPMS database and rebalancing the index quarterly, the result is an annualized total return of 12.2 per cent. The S&P 500 Total Return index generated an annualized return of 8.1 per cent over the same period.

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For the past five years, the Dividend Target 50 index strategy shows an annualized return of 6.9 per cent, versus 0.4 per cent for the S&P 500 Total Return.

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