Mutual Funds' Dividends Prop Up Returns

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.

Another solid fund is Mutual Shares ( TESIX), which has returned 4.5% annually during the past decade, outperforming 88% of competitors. A deep-value specialist, the fund seeks stocks that have little-downside risk because the shares are already depressed. Manager Peter Langerman favors companies with rich cash flows. When he can't find any bargains, Langerman holds cash.

The fund often buys distressed securities or merger stocks. Those can provide diversification because they sometimes rise when markets are falling.

Mutual Shares has long favored tobacco companies, which are perennially shunned by many investors. A big holding is British American Tobacco ( BTI). The stock boasts a dividend yield of 7.4%. The company is benefitting from increasing sales in the emerging markets.

Mutual Shares also holds Kraft Foods ( KFT), which yields 4.1%. The food giant is a steady performer that is delivering improving sales and earnings.

For a fund that excels in downturns, consider Columbia Dividend Income ( LBSAX), which has returned 4% annually during the past 10 years, beating 82% of competitors. During the downturn of 2008, Columbia lost 28%, outpacing the S&P 500 by 9 percentage points and topping 95% of its peers.

The fund favors rock-solid companies that can increase their dividends year after year. A favorite holding is Exxon Mobil ( XOM). Manager Dick Dahlberg says the oil company has long been an extremely reliable performer, topping the S&P 500 over the past three decades. "Exxon Mobil increases its dividend about 8% every year," he says. "They don't goose up the dividend in good years and cut it down in bad times."

Dahlberg also likes hamburger giant McDonald's ( MCD), which yields 3.3%. Although the recession has slowed sales, the company continues to generate a high return on equity.
Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.