Payout Standouts: Dividend Income Mutual Funds Soothe the Urge for Cash: Mutual Fund Focus, December 2009

Dividends are a considerable temptation for most investors

News and analysis from Standard & Poor's MarketScope Advisor

There are as many reasons to like dividends as there are things to spend dividends on: who can truly complain about a regular stream of cash payments as thanks for owning stock? After all, sharing in a company's profitability is one good reason to own stocks in the first place.

Dividend stocks have performed surprisingly well over the past decade, with the dividend-paying stocks of the Standard & Poor's 500 outperforming non-payers on an average annual return basis in eight of the nine years since 2000, according to Standard & Poor's Index Services.

Mindful that outsized dividend yields can be a warning sign of lost confidence in the company that pays them, S&P Equity Research's Chief Investment Strategist Sam Stovall recommends investors not buy stocks based on their dividend yield alone, but in conjunction with other fundamental indicators. For those who would rather have a professional manager make that call, there are more than 100 domestic equity mutual funds that describe themselves as income- or dividend-oriented. Of the 23 dividend and income funds that hold S&P's highest 5-star rank, three stand out as particularly attractive for their consistently strong performance as well as their low costs.

Amana Income Fund (AMANX ), one of just three funds run by Bellingham, Washington-based Amana Mutual Funds Trust, has outperformed most of its peers over the past one-, three-, and five-year periods, with its 7.89% average annual return over the past five years higher than any other 5-star dividend fund. It is also one of the few such funds with a positive annual return over the past three years, helping to justify its above-average 1.33% net expense ratio. The $991 million fund, which has been in business since 1986, owns shares in 79 large-cap stocks, mostly U.S. corporations but also American depositary receipts and shares in large overseas companies such as E.On (EONGY) and Vodafone (VOD). It adheres to Islamic investing principles, so it won't buy shares in companies involved in banking, alcohol, gambling, and it doesn't own any fixed income securities. The fund has an ultra-low turnover rate of just 6%. Its top three holdings as of Nov. 30, 2009 were Pfizer (PFE), Johnson and Johnson (JNJ), and Abbott Laboratories (ABT). Despite that concentration of healthcare names at the top of the list, the fund also offers sector diversification. It has about 16% of its assets in industrials and another 12% in materials. S&P Equity Strategy currently advises an "overweighting" of both of those sectors.

Another consistent performer is San Francisco-based Parnassus Investments' Equity Income Fund (PRBLX), a large-cap fund that maintains at least 75% of its $1.93 billion in assets in dividend-paying stocks. Like the Amana fund, it has ranked among the top three 5-star dividend funds over the past one-, three-, and five-year periods for average annual return. The fund, which opened in 1992 and charges net expenses of 0.99%, had 41 different holdings as of Sept. 30, 2009, with turnover of 70% in 2008. Its three largest holdings were Microsoft (MSFT), Waste Management (WM), and Proctor & Gamble (PG), which, combined, accounted for more than 16% of its assets.

The Nicholas Equity Income Fund (NSEIX), a $48 million fund run by Milwaukee-based Nicholas Advisors, has been buying dividend stocks since the fund launched in 1993, with the refreshingly pragmatic mission to provide "a reasonable stream of income" and "moderate long-term growth of capital." Its 5.37% five-year and 1.39% three-year average annual returns are better than most of its 5-star peers, and its nearly 30% return in 2009 is the best of the group. The fund, which charges net expenses of 0.9%, generally holds smaller stocks than other dividend income funds, with its weighted median market capitalization only $2.6 billion as of Sept. 30, 2009. Its three largest holdings were Oshkosh (OSK), Dorchester Minerals (DMLP), and Integrys Energy (TEG).

S&P Senior Financial Writer Vaughan Scully can be reached at Vaughan_scully@standardandpoors.com. Send him your ideas for mutual fund story topics. .

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