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Use Ben Graham's Model for Dividend-Oriented Portfolio

National Oilwell Varco and IDT are two good companies to include.
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I went over to Winter Park Wednesday night and dropped in at the Central Florida chapter of the American Association for Individual Investors. I try to go to these when I can as I usually meet some interesting folks and have some really enjoyable discussions.

I am not a fan of the traffic going cross town, but on the meeting nights when I can steel myself up for the joys of Interstate 4, I head over.

Last night's meeting didn't have a speaker, but more of a roundtable discussion and I came away with a couple of conclusions. First, the need for better investor education is enormous. These were folks who are engaged in the markets on a daily basis and some of the things they just don't know or were not aware of was a little frightening. AAII is a fantastic organization and those at the meeting are seeking to learn, but the curve is steep.

The other thing I took away was that the search for yield is still very much in order. MLPs, REITs and dividend-paying stocks were the order of the day. Even better if you could get your yield from an ETF like the Dividend Aristocrats (NOBL).

While I love a good dividend aristocrat, I am all too aware that everything has a price to tag and sometimes that price is too high, or on rare occasion just too cheap not to buy. It is the former right now for this ETF. The current price-to-earnings ratio of the average company in the portfolio was 19.6 as of the end of March. The price-to-book value was 3.6. You have no margin of safety and you are taking a lot of risk to collect your 1.65%. iShares Dividend Select (DVY) was a little better at 18.1x earnings and 2.1x book value, but they are hardly a bargain.

I haven't written about income-producing stocks in a while. I sat down and started running screens and kicking over rocks to see if I can put together a dividend- oriented portfolio. I wanted one that would meet or exceed the level of the dividend ETFs and still meet the qualifications of a value portfolio.

In his last interviews before he passed away, Ben Graham suggested that a portfolio of 30 stocks was about right. Let's see if we can pull out all the stops and use all the tools we have available to get together a fully-invested income portfolio.

First, we will just add a dividend component to Grahams two-step model that he described in 1976. He said that a stocks with just two characteristics, a PE Ratio of less than 10 and debt to equity levels less than 50% , would beat the market. It has been pretty thoroughly tested, most recently by Tobias Carlisle and Wesley Gray, and it does indeed handily beat the overall stock market.  This screen gets us off to a slow start as not that many higher-yielding stocks make the grade

National Oilwell Varco (NOV) makes the grade. The oil services company has seen its stock price decline by 30% over the past year and now trades at just 9.6 times earnings. At this price the stock yields 3.67%. The company is going to continue to be tied to oil prices. If Goldman Sachs is right and we have $45 a barrel oil, then the company and stock price could struggle. If T.Boone Pickens is right and we have oil over $70 next year, the stock will be a huge winner from current levels. We collect the dividend In the meantime.

IDT Corporation (IDT) makes the list of cheap dividend payers. The stock trades at a PE of just 4 right now and yields 4.07%. IDT provides retail telecommunications and payment services to help immigrants and the under-banked.  They also have developed Zedge, a popular app for mobile content discovery and acquisition. It is an interesting company and the potential of some of their business lines is enormous if they execute correctly over the next several years.

That is as far as this screen can take us. To fill out the 30-stock portfolio,  we will have to work harder than just one simple screen. We will take a look Friday at what happens when we use some of Graham's other methodologies and quantitative techniques to continue building a safe and cheap income portfolio.

At the time of publication Melvin had no positions in stocks mentioned.