Focus on dividend growth

NEW YORK — Get ready to start paying attention to another number in your equity mutual fund portfolio: yield.

Stock funds aren’t typically associated with income, but with more companies paying out dividends, Wall Street has a renewed enthusiasm for dividend-focused mutual funds. A tax cut last year has also helped increase their popularity.

Regular dividends are often viewed as a good sign of financial health. Companies that pay them are usually larger, less-risky value stocks with stable balance sheets. For long-term investors, dividend-focused mutual funds can provide a welcome element of steady growth.

“Unless there’s an investment opportunity that would increase shareholder value, a dividend is a pretty good thing for a company to do with its money,” said Paul Herbert, senior mutual fund analyst at Morningstar Inc. “You can bank on a dividend.”

During the go-go years of the tech boom, when overnight profits were all the rage, many investors preferred not to bother with the dull growth of dividends, and some companies stopped paying them altogether. In 2002, only 350 companies in the Standard & Poor’s 500 paid dividends. That number has climbed to 376 now, but it’s still far from the 469 that paid dividends at the end of 1980.

It’s not a new idea for a fund to focus on dividend-paying stocks, Herbert said. Most mutual fund shops, including T. Rowe Price, Fidelity, Vanguard and American Funds, offer dividend growth or equity income funds. For more conservative investors, these can be good core funds because the stability of their underlying holdings make them less volatile.

The holdings of these funds depend largely on the individual manager’s style and may not even be limited to companies that pay dividends. As a rule, however, dividend growth funds tend to focus on higher-quality growth companies with a good history of consistently raising their dividends. Equity income funds are usually more concerned with producing a very competitive current yield relative to the S&P — currently about 1.6 percent. In both cases, the focus is on total return, meaning all of the income derived from dividends, capital gains and share price fluctuations.

For investors focused on current income, equity fund yields still are no match for bonds. Few stock funds, regardless of their holdings, have yields higher than 1.5 percent; at that level, the annual yield return on an investment of $10,000 would be only $150. In most cases, however, equity income or dividend growth funds will reliably produce a higher yield than money market funds.

In the current climate, a more conservative investor might like to combine short-term bonds with dividend-paying stocks. An example is the Hennessy Balanced Fund, which invests equally in one-year U.S. Treasuries and the 10 highest-yielding stocks on the Dow Jones industrial average, known as the “Dogs of the Dow.” Another dividend-focused Hennessy Fund, Cornerstone Value, contains 50 high-yielding stocks.

“It’s not what you make on the upside, it’s what you don’t lose on the downside,” said Neil Hennessy, the group’s president and portfolio manager. “When you’re starting out you can take the volatility, you’re fine. But as you build a nest egg, you want less volatility … J.P. Morgan, General Motors, Dupont, Citigroup, Exxon … these stocks are going to be around a long time.”