In other words, most growth stocks don’t pay dividends because they are less mature and have more room to grow than mature companies that are more likely to pay dividends. On the other hand, the fact that dividend-paying companies are established and have a significant market share makes dividend stocks less volatile than growth stocks. As a result, the best dividend stocks—those companies that have grown their profits like clockwork decade after decade—can provide excellent overall returns, even if they show staggering returns. While this may seem counterintuitive, companies that consistently pay and increase dividends have historically outperformed non-dividend stocks, further adding to investors’ appeal to dividend growth.
Dividend-earning stocks are generally considered a safe investment, and the annual growth in dividends is regarded as a definite bonus that will significantly increase passive income over time. To clarify, most dividend investors invest primarily in cash flow and not in capital gains in the market as growth investors do, although capital gains are a nice bonus. Dividend stocks offer a constant cash flow, which is potentially less risky than growth stocks because the investor receives money at regular intervals. Investors who buy growth stocks receive income from future capital gains (the difference between the amount paid for a share and its current value), not dividends.
Although dividends are sometimes paid to shareholders of growth stocks, historically growing companies have more often reinvested retained earnings in equity projects. However, due to changes in tax laws that reduced the corporate tax rate on dividends, growth companies have also offered dividends. The open market often places a high value on rising stocks; therefore, investors in growth stocks may view them as highly valuable and be willing to pay more for their stock. Due to growth expectations, these shares are selling at a higher price as measured by their price-to-earnings ratio.
It’s a nice bonus if your stock also pays dividends along the way, but most of your income will come from rising stock prices. Investing in growth means your cash flow will be more intermittent than investing in dividends, but in more significant amounts because your money comes from selling those shares all at once. Conversely, investing in dividends means you’ll have a more stable cash flow than growth investments because these stocks bring regular cash payments over time.
What Are Dividend Vs Growth Stocks
However, your investment will grow over time, and dividend investing, on the other hand, is for those investors who have been looking for steady cash flow over the years. Companies that can continue to pay annual dividends can be suitable investments, especially those that consistently increase their payout levels. A high dividend yield isn’t bad for an established company with a significant market share, but the company also has to show some growth in the form of higher earnings and enough free cash flow to pay the dividend.
If a company pays the equivalent of a 2% yield in dividends, management effectively tells investors that they can’t find a better investment in a company with a yield higher than 2%. The company pays dividends because management cannot find the best growth opportunities within the company to invest in retained earnings. However, this reinvestment tends to add value to the company over time.
Instead of distributing dividends, the company’s profits are reinvested in equity projects as retained earnings. In the case of dividends, the excess profits generated from shares are declared and shared with investors and the excess profits are taken only as a dividend. In contrast, the excess profits earned are reinvested in the growth model, and the profits only materialize when they are repurchased or sold.
Some stocks pay regular dividends, but by choosing the growth option, the mutual fund holder allows the fund company to reinvest the money it would otherwise payout to the investor in dividends. With the opportunity for growth, the investor enables the fund to invest dividends in multiple stocks and eventually grow their money. The growth option in a mutual fund means that the investor in the fund will not receive any dividends that can be paid out of the mutual fund’s shares.
Again, no cash is paid to the investor when the fund shares are dividends. Instead, the fund used all the dividends that should have been paid to invest in more shares and increase client money. Thus, dividend investors make money whether the stock goes up or down.
It would be best to diversify with some growth assets, but for most of your investments, you will be looking for stocks with a history of consistent and meaningful dividend payouts. It would be best to diversify this with some dividend assets, but most of your investment will go towards companies reinvesting their profits back into themselves. Many investors move dividends into their portfolios, either by using the money to buy more of the same assets (allowing their investments to grow on themselves) or by buying multiple dividend-paying stocks (allowing the portfolio to self-diversify).
On the other hand, quality dividend growth stocks can provide you with a growing return on your investment, which you can then reinvest in more stocks, creating an exponentially growing income stream over time. And if you reinvest dividends over time in quality dividend growth stocks, even if the market crashes, you will still be in a better position because you can reinvest your growing dividend income stream with a lower post-crash price fix and higher performance. So whether you invest in high-yielding companies or companies with growing payouts, dividend investing can be a reliable way to generate a stream of income from your portfolio.
By keeping a firm hand and staying disciplined, investing in rising dividend stocks can provide you with a steady and growing income stream that can cover your needs, desires, and retirement over time. Good dividend stocks, such as those on the Dividend Aristocrats list, will then adjust capital gains after a market downturn and have a lighter rebound than growth stocks, which may never recover from a severe recession. Dividend-paying companies will have an easier time recovering from a market crash than growth stocks.
If the amount of growth cannot exceed the value lost due to dividends over time, the company is likely to fall in value. So as a growth investor, you will only buy a stock if you are confident that it will rise in value over time. Also, if you invest in stocks because you think it will change the industry or because the company is innovative (like AAPL), it could get you more than good dividend-paying stocks.
Another approach to investing in dividends is looking for stocks of companies with a solid track record of increasing dividend payouts per share annually. Mature companies usually hold value stocks with a stable history of paying dividends.