Looking for Dividend Stars

Vanguard Dividend Growth seeks out companies with the ability to boost payouts to shareholders.

Funds that focus on dividend-paying stocks come in all stripes. Some specialize in sectors, such as real estate investment trusts or utilities, that are associated with high-yielding stocks. Some fill up on beaten-down value stocks with above-average yields. Others are concerned more with future dividend growth than with high current yields. One such fund is Vanguard Dividend Growth (symbol VDIGX), which seeks strong, steadily growing companies that boost their dividend payouts year after year. "The fund's main thrust is to grow dividend income over time," says Donald Kilbride, the fund's manager since February 2006. Over the past year through March 21, the fund returned 14.0%, beating Standard & Poor's 500-stock index by 1.3 percentage point, according to Morningstar.

When considering a company, Kilbride begins by estimating how big a dividend it might pay in five years. To do this, he assesses the company's dividend history, its free cash flow (the cash that's available to make acquisitions, buy back shares and pay dividends), and management's willingness to continue boosting the payouts. "I want to own companies in which I have a high conviction that there is a dividend growth story," he says.

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Staff Writer, Kiplinger's Personal Finance