By Katy Marquardt

Quality matters in a market like this. That's a no-brainer. But how do you know if a stock is "quality"? Dividends are one indicator. That's because dividend income -- which is essentially a portion of company profits paid out to shareholders -- helps offset fluctuations in a stock's share price, often creating a cushion during volatile markets. Stocks that pay dividends "tend to be very solid, stable types of investments and often end up being the class act of corporate America from an investor's standpoint," says Morningstar analyst Christopher Davis. "These companies ... tend to have some sort of competitive advantage that allows them to generate excess free cash flow that they can distribute to shareholders."

Funds that focus on dividend-paying stocks vary in strategy. Some sit squarely in the value camp and contain bargain-priced stocks with above-average yields. Some search for dividends abroad. Others focus more on future dividend growth than on high current yields. Here is a sampling of funds -- including one ETF -- that take different approaches to satisfy dividend devotees.


The managers of U.S. News's top-ranked large-value fund sift through the universe of large companies using several criteria: stocks must have dividend payouts greater than the average yield of the S&P 500, and they must have price-to-earnings, price-to-book, and debt-to-capital ratios below the S&P 500 average. Beyond that, managers James Cullen and John Gould dig into company fundamentals to determine if a company is likely to continually increase its payouts in the future.

The managers also look for opportunities abroad: Currently, nearly 20 percent of the portfolio's assets are in foreign stocks, including multinational giants AstraZeneca and Diageo. Stateside holdings include Boeing, Johnson & Johnson, and Kraft Foods. Cullen High Dividend Equity weathered 2008 better than most large-cap value funds, but it lagged the pack in 2009's rally. Over the longer term, the fund's measured strategy has paid off: Over the past one, three, and five years, the fund's returns rank in the top 20 percent of its category. The fund currently yields 2.37 percent and charges 1 percent in annual fees.


Investors may be surprised to learn that Asia boasts some of the highest-yielding stocks in the world. Matthews Asia Dividend proposes a safer way to play this region by investing in companies that pay consistent and growing dividends, which managers Jesper Madsen and Andrew Foster believe "often signals companies that exhibit solid market positions, sustainable business models, and better management teams," according to fund commentary. More than 20 percent of the fund's portfolio is currently dedicated to Japanese companies, which have been improving their dividend policies over the past five years, according to Madsen.

The fund's 2008 loss of 26 percent was significant; still, it bested virtually all of its peers, which suffered an average loss of 43 percent. Over the past one and three years, Matthews Asia Dividend -- U.S. News's top-ranked fund among diversified funds that invest in Asia and the Pacific -- ranks in the top 1 percent its category, according to Morningstar. The fund yields 3.32 percent and charges 1.30 percent in annual fees.

3. VIG

Investors seeking dividends on the cheap might consider Vanguard Dividend Appreciation, an exchange-traded fund that tracks the Dividend Achievers Select Index. Although the fund's 142 stocks are spread across a range of sectors and industries, each member has a history of boosting its dividend payouts over time. A requirement of inclusion in the index -- and therefore, the fund -- is that companies must have increased their annual dividends for at least the past 10 years. Stocks in the fund typically have ample cash on hand, strong balance sheets, and consistent earnings growth.

Big names dominate Vanguard Dividend Appreciation, including PepsiCo, Procter & Gamble, and McDonald's Corp. (mid- and small-cap stocks occupy a relatively small slice of the portfolio). The fund ended 2008 with a 27 percent loss, 12 percentage points less than the average of all large-cap blend ETFs. Its three-year annualized return ranks it in the top 1 percent of its category. The fund (symbol VIG), yields 2.18 percent and levies annual fees of 0.23 percent.


Here's a dividend-oriented fund for socially conscious investors. Not only does Parnassus Equity Income screen out companies that make alcohol, tobacco, or weapons, it seeks those that are environmentally friendly, treat their employees well, and support the communities in which they operate. Manager Todd Ahlsten invests mainly in large dividend payers but also reserves room in the portfolio for midsize and small companies. To estimate a company's intrinsic value, he uses a handful of metrics such as price-to-book value, and he also seeks firms that have competitive advantages and are likely to raise dividends in the future.

Parnassus's current yield, 1.27 percent, is low compared with other funds on this list. "It's worth pointing out that just because the fund focuses on growing dividends doesn't necessarily mean the yield is going to be all that high," says Morningstar's Davis. "If you have a low-yielding stock that doubles its dividend, it may still end up being low yielding. Income-oriented investors may not find a fund like that appealing, but it's still a fine core holding because companies are increasing their dividends year after year after year."

So far this year, Parnassus Equity Income is in the red and lagging its large-cap blend peers by more than 1 percent, but its long-term results may be a better measure of its strength: The fund has ranked in the top 5 percent of its category over the past three-, five-, and 10-year periods. The fund charges 0.99 percent in annual fees.


This fund, which is among the top long-term performers in U.S. News's large-value list, invests according to Islamic principles. That means it avoids companies that draw significant revenue from alcohol, tobacco, pork, gambling, or pornography. Another significant twist: Amana rules out companies in the business of borrowing or lending money, so financial stocks, which heavily populate most dividend-oriented funds, are also out. That helps explain why Amana led the pack in 2007 and 2008. It ranks in the top 1 percent of its category over the past three and five years. Manager Nicholas Kaiser buys only stocks that pay a dividend, and the fund is heavy on consumer goods, healthcare, and industrial materials stocks. Amana Trust Income charges 1.25 percent in annual fees and yields 1.23 percent.


It's hard to argue with this fund's exceptionally consistent record. Since its 1985 launch, it has lost money in only three calendar years: 1990, 2002, and of course, 2008. Manager Brian Rogers, who is also chairman and chief investment officer of T. Rowe Price, often buys out-of-favor companies struggling with temporary setbacks. He also looks for stocks with dividend yields that are higher than the S&P 500-stock index average. Top holdings recently included JP Morgan Chase, Bank of America, and General Electric. The fund, which currently yields 1.8 percent, has gained an annualized 11 percent since its inception. It charges 0.73 percent in annual fees.


This fund hones in on strong, steadily growing companies with a long history of boosting their dividend payouts year after year. When considering a company for the portfolio, manager Donald Kilbride estimates how sizable a dividend it might pay in five years. He takes into account the company's dividend history, its free cash flow (a measure of profitability), and the management's willingness to continue raising the payouts. This strategy steers the fund toward industry giants with strong brand names such as Johnson & Johnson and PepsiCo, which tend to hold up in times of market turbulence. This is not a high-flying fund -- it has been trailing the majority of its peers since stocks began their rally in 2009 -- but its longer term performance is solid. Over the past three and five years, the fund ranks in the top 10 percent if its large-cap blend category. It yields 2.14 percent and levies annual expenses of 0.38 percent.

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