For steady returns, consider dividend-paying stocks and equity income funds

In July 1987, when Wall Street bulls were lifting the stock market, the American Funds Group launched an equity fund whose investment objective was income -- with a twist.

The fund, Capital Income Builder, was designed to provide shareholders with a yield exceeding that of the Standard & Poor's 500 Composite Stock Price Index, as well as with a growing stream of income. It would also try to increase its dividend every quarter -- a goal unmatched by any other fund.


Five years later, the concept designed by Capital Research and Management Company, the group's investment adviser, can be regarded as a success: The September dividend reflected the 20th consecutive quarterly increase.

That wasn't all. Posting its first five-year performance record -- for the period ended Sept. 30 -- Capital Income Builder led the list of equity income funds tracked by Lipper Analytical Services, with an average annual total return of 13.1 percent. That was well ahead of the S&P; 500's five-year average of 9.0 percent.


Impressive as the total return (price appreciation plus reinvested dividends) for these turbulent years is, it is the consistent increase in dividends that is most worth noting. It illustrates two key points:

* You can earn increasing income from a well-managed portfolio invested primarily in the common stocks of corporations whose profits and dividend payments grow.

* You can find such portfolios among the 70 equity income funds -- funds that aim to earn relatively high income by investing in dividend-paying equities.

To appreciate the potential for increased income from dividend-paying stocks and equity income funds, compare them with fixed-income securities (which, of course, are less risky).

For example, a five-year, 8.375 percent U.S. Treasury note, issued about the time Capital Income Builder was first offered to the public, has been paying a fixed $41.88 in interest per $1,000 principal every May and November.

CIB's latest dividend of 38 cents per share, on the other hand, was 35.7 percent higher than its first of 28 cents. That reflects an annual growth rate of 6.3 percent -- well above the period's inflation rate of about 4 percent.

To generate income for its dividend payments, CIB is concentrated in stocks of three kinds of companies: those providing above-average current income; those providing both a good yield and prospects for good dividend growth; and those paying low yields but having prospects for rapid dividend growth.

Among its top equity holdings: utilities, telecommunications, banking and energy companies.


Strategies differ among other leading equity income funds, in part because of the varying emphasis between high current dividends and higher future dividends.

Flag Investors Telephone Income Fund, 80 percent invested in stocks, puts money primarily in the telephone industry, here and abroad, and owns other stocks -- such as in insurance -- to enhance income.

Although still high on the regional Bell operating companies -- especially Southwestern Bell, Pacific Tel, and NYNEX -- the portfolio manager, Bruce E. Behrens, let their share of his portfolio drop to 32 percent as he invested new money elsewhere. Mr. Behrens is concerned that the cash requirements of the Bell companies' expansion programs may retard growth in dividend payments.

At Baltimore-based T. Rowe Price Equity Income Fund -- which is 70

percent in stocks, the rest split between bonds and cash -- the portfolio manager, Brian C. Rogers, has sold utilities whose prices had been bid up by other yield-seekers. He has replaced them with stocks he regards as better values, like Bristol Myers-Squibb, Georgia Pacific and Reynolds Metals.

Still a leading long-term performer despite poor 1992 results, Financial Industrial Income Fund has been concentrated in growth stocks -- notably health care -- and suffered this year.


To give the portfolio a more defensive mix, the fund has been increasing its bond holdings -- reducing the equity allocation from 70 percent to 65 percent. Philip J. Dubuque, co-manager, says the fund's health-care position has been cut in half while bank stocks have been bought. "Banks will have earnings surprises," he says.

Eric Ryback, portfolio manager of Lindner Dividend Fund, has been able to maintain an 8 percent dividend by investing about 30 percent of his fund's assets in convertible preferred stocks and bonds, 35 percent in nonconvertible preferred and nearly 20 percent in "junk" bonds. While the convertibles are, of course, linked to the stock market, only 14 percent of the fund is in common stocks.

Mr. Ryback attributes the fund's appreciation in the last year to the decline in interest rates and to "turn-arounds" among companies whose convertible securities it owns.