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TheStreet Open House

Mutual Funds' Dividends Prop Up Returns

Stock quotes in this article: KFT, XOM, MCD

NEW YORK ( TheStreet) -- With stock markets sinking lately, investors have been dumping equity funds.

During the week ending May 26, shareholders withdrew $13.4 billion from domestic stock funds, according to the Investment Company Institute. That was the biggest outflow since the dark days of March 2009.

But instead of fleeing stocks, investors should consider buying. Despite uncertainties in Europe, corporate profits are spiking as businesses cut costs and report growing revenue. Most stocks seem priced at moderate valuations.

To place a bet that the economic recovery will continue, consider large value funds. For much of last year's rebound, large value stocks lagged. During the past year, large value funds returned 20%, trailing small value funds by 14 percentage points, according to Morningstar. Large value funds sell for a price-to-earnings ratio of 14, a modest figure at a time when small growth funds command a multiple of 18.8.

Some top large value funds are especially compelling in today's uncertain environment because they focus on solid dividend-paying stocks. If markets remain volatile, the dividend income could prop up the funds.

For a low-risk choice, consider Amana Trust Income (AMANX), which returned 5.5% annually during the past 10 years, outdoing 97% of competitors. Manager Nick Kaiser buys high-quality stocks that sell at reasonable prices. "Our emphasis is on safety and capital preservation," Kaiser says.

When markets seem rough, Amana holds cash. During the downturn of 2008, the fund had 32% of assets in cash, which limited losses.

These days, Kaiser still has 20% in cash, but he is finding more stocks to buy. A favorite holding is tool maker Stanley Black & Decker (SWK). The recession hurt sales, but earnings have improved as the company has cut costs. He also owns Pepsi (PEP), a steady performer that sells for a modest P/E multiple of 15.

While Amana is a sound choice for investors of all stripes, the fund is designed to serve Muslims. Because Islamic law frowns on making loans, the fund steers away from companies that are heavily indebted. That has helped protect shareholders in downturns when leveraged companies can collapse.

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