Nicholas Equity Income Fund

A focus on yield and cheap stocks helps this fund hold down risk.

Editor's Note: This story has been updated since its original publication in the November issue of Kiplinger's Personal Finance magazine.

Albert "Ab" Nicholas was one of the fund industry's star managers in the 1970s and ’80s. Since then, Nicholas and his small group of funds have receded from the limelight. But the funds have continued to produce pleasing, if not scintillating, results over the years. One of the best performers has been Nicholas Equity Income (symbol NSEIX (opens in new tab)), which seems perfectly suited to today’s volatile markets.

Nicholas, 80, and co-manager Michael Shelton, 39, invest only in dividend-paying companies, preferably those that they believe will keep boosting their payouts. They favor stocks with dividend yields that exceed the current yield of Standard & Poor’s-500 stock index. And they prefer that a stock’s yield combined with the underlying company’s expected annual earnings growth equal or exceed 10%. As of October 21, the fund yielded 3.0, compared with 2.5% for the S&P index.

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Thanks to its focus on dividends, Nicholas Equity Income has held up better historically than other stock funds in down markets. For example, during the 2007-09 bear market, during which the S&P 500 lost 55.3%, Nicholas sank 48.0%. In the 2000-02 downturn, the S&P tumbled 47.4%, while the fund lost only 12.1%. Nicholas didn’t have as large an edge during the April 29 - October 3 correction; it lost 17.8%, compared with a drop of 18.6% for the S&P index.

The fund’s long-term numbers are fine. Over the past three years, it returned 16.0% annualized, compared with 11.5% for the S&P 500 and 14.0% for the typical fund that focuses on undervalued, midsize companies. Over the past ten years, Nicholas gained 7.5% annualized, compared with 3.4% for the S&P 500 and 7.0% for the average mid-cap value fund. “Over long periods of time, dividends make up 30% to 60% of total return,” says Nicholas. “Plus, you can sleep at night with this portfolio.”

The fund’s yield would be higher, Nicholas says, were it not for the funky accounting of the many master limited partnerships it owns. MLP payouts are mainly return of capital and are handled differently than dividends of traditional companies. Beyond dividends, the managers look for out-of-favor stocks with low price-earnings ratios. They like firms with strong balance sheets, a record of consistent earnings growth, low debt, a strong brand, a return on equity (a measure of profitability) of at least 15% and an ability to prosper even during hard times. “We won’t buy a company for a high yield if it isn’t capable of growing its earnings and, therefore, its dividends,” says Nicholas.

Although Equity Income tilts toward small and midsize companies, it has about one-fourth of its assets in shares of large firms. At last report, the fund held some familiar names, such as AT&T (T (opens in new tab)) and Pfizer (PFE (opens in new tab)), as well as more-obscure firms, such as Rocky Mountain Chocolate Factory (RMCF (opens in new tab)), Dorchester Minerals (DMLP (opens in new tab)), and appliance maker National Presto Industries (NPK (opens in new tab)). Nicholas also holds tobacco makers Altria (MO (opens in new tab)) and Philip Morris International (PM (opens in new tab)), which used to be part of Altria. PM yields 4.4%, while Altria yields a hefty 6.0%.

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Jennifer Schonberger
Staff Writer, Kiplinger's Personal Finance