I came across an article written by Financial Samurai (or Sam), who worked in the finance industry for 13 years. The article was titled: Why It's Better To Invest In Growth Stocks Over Dividend Stocks For Younger Investors.
I don't entirely agree or disagree with the author, but I'll quote from the article to generate a discussion on if younger investors are better off focusing more on dividend stocks than growth stocks.
It takes a lot of capital to generate meaningful income
Sam starts off saying:
Even if you have a $500,000 dividend stock portfolio yielding 3% that's only $15,000 a year.
His argument was that it takes a lot of capital to generate a meaningful amount of income. If you're earning an average salary, it would take years to save $500,000. Investing can get you there faster, though.
Here are a few scenarios, assuming compounded annually at an 8% rate of return, which is a reasonable return for a dividend investing strategy. Here's how long it'd take to reach a +$500,000 portfolio.
Stock investment per month Years $500 25 $1,000 18 $2,000 12
Never mind accumulating a big portfolio. Here are different ways on how to double your money.
Young people are better off focusing on growth stocks
Sam opines that:
If you're relatively young, say under 40 years old, investing the majority of your equity exposure in dividend yielding stocks is a suboptimal investment strategy.
He continues that:
Out of the few multi-bagger return stocks I've had over the past 16 years, none of them have been dividend stocks.
Now, I think the reason that none of Sam's multi-baggers were dividend stocks because he was focused on looking for growth stocks.
Although none of the multi-baggers he owned were dividend stocks, there are always examples if you look for them.
Alimentation Couche-Tard Inc. [TSX:ATD.B] (OTCPK:ANCUF)(OTC:ANCTF) started paying a dividend in 2005. Since then, the stock has appreciated 700% - a dividend-paying multi-bagger.
Starbucks Corporation (NASDAQ:SBUX) started paying a dividend in 2010. Since then, the stock has appreciated 360% - another dividend-paying multi-bagger.
Of course, Couche-Tard and Starbucks were growth stocks to begin with, but just because they started paying a dividend, it doesn't mean they won't continue to have good growth.
In fact, from FY2006-2016, Couche-Tard compounded its earnings per share (EPS) at an average rate of 22.4% annually! Similarly, from FY2010-2015, Starbucks compounded its EPS at an average rate of 19.8% annually.
When a growth stock starts paying a dividend (especially a growing dividend such as in the case of Couche-Tard and Starbucks), it means management believes earnings and or cash flows are stable enough. This is a good sign for long-term investors looking for stable returns.
That said, Sam also gave which I thought was a fair comment:
[I] will attempt to argue why younger investors should focus on growth stocks over dividend stocks in a bull market with potentially rising interest rates. In a bear market, everything gets crushed but dividend stocks should theoretically outperform.
The problem is no one knows when the next crash will occur. Maybe it has already started.
On top of that, there are benefits in holding quality stocks that pay decent dividends. Psychologically, such stocks yielding typically 3-5% are easier to hold onto than growth stocks which pay no dividends and are typically more volatile. That is, in a down market, growth stocks are likely to fall harder.
Why do companies pay dividends?
Sam says:
The main reason companies pay dividends is because management cannot find better growth opportunities within its own company to invest its retained earnings.
I agree with Sam. However, it's not necessarily a bad thing that management starts paying a dividend because of that. Cash returned as dividends to shareholders can be used to be reinvested elsewhere or for buying groceries. It's better than management misusing it to invest in what they shouldn't or overpaying for an investment.
The author goes on to compare the stock price performance of Tesla (NASDAQ:TSLA) and AT&T (NYSE:T). He mentions about the AT&T's 5% yield, but the focus was on Tesla's price performance trumping that of AT&T's. Indeed, since Tesla's IPO, it has appreciated over 900% but AT&T only appreciated over 60% in that period.
Source: Google Finance
Even after adding in AT&T's dividend return, its total return would have been only 109% in that period.
Anyway, an investor who buys Tesla would have very different reasons from an investor buying AT&T. One would invest in Tesla for potential exceptional growth and another would invest in AT&T for a safe, current income.
A dividend investor who's looking for more growth wouldn't consider AT&T which has grown its dividend by 2% a year in the last seven years. Instead, they would consider stocks like Couche-Tard and Starbucks when they're priced at discounted or reasonable valuations.
The hard part with investing in growth stocks is knowing when to buy and sell. Okay, so this actually applies to all stock investing, but I'd argue that it's more difficult to determine when to buy and sell growth stocks than dividend stocks.
I'd also argue that growth holdings that pay no dividends require more time and attention to manage than dividend holdings. As a result, a growth portfolio would likely lead to more trading than a dividend portfolio.
Knowledge and experience is a factor
The author had 13 years of experience working in finance, but lots of young people don't. It can be especially dangerous for young investors (with little or no experience in investing) to chase growth only to buy at possibly a high and to be disappointed (perhaps scared when their growth stocks fall) and end up losing capital by selling low.
Imagine if a young guy with little investment experience decides to buy Tesla at $250 a share in 2015 and couldn't hold on when it dipped (quite rapidly might I add) to the low $140s per share in early 2016.
Buy and hold? No Thank you
The author is also not a fan of buy and hold as he lists companies that no longer exists, including WorldCom, Enron, and Lehman Brothers.
This is why you cannot blatantly buy and hold forever. You've got to stay on top of your investments at least once a quarter.
I agree with having to stay on top of your stock investments. It can be dangerous if investors think dividend investing is safe (at least safer and less volatile than growth stocks) and not follow the progress of the underlying businesses driving the long-term stock performance (whether you're looking for dividends or growth).
For example, at least dividend investors should strive to look for stocks with safe dividends. One way is to determine what is a good dividend payout ratio.
Sam says:
You do not buy REITs and dividend yielding stocks in a rising interest rate environment.
The author then used Realty Income Corp (NYSE:O) as an example when its share price fell a scary dip from $55 to $46 in 2013. The shares actually fell lower after that due to the continued interest rate hike fears at the time.
Source: Google Finance - Realty Income 2013 price action
However, looking back, the 2013 dips were excellent times to buy, as the quality shares fell to more reasonable valuations compared to historical norms.
Source: F.A.S.T. Graphs - Buy when quality shares trade at or below fair valuation.
Today, the shares sit at higher levels than 2013. However, the shares are too overvalued for buying today. Some might even argue to take some profit. The shares trade at a P/FFO of more than 21 with FFO per share expected to grow about 4% per year.
Source: Google Finance - Long-term view. Buy on dips?!
Sam argues it's very difficult to build a sizable portfolio by just investing in dividend stocks. I don't argue against that. However, I do think that dividend investing (combined with value investing) is great for new investors to learn from.
While young investors are learning and investing, they can collect dividends. And there's nothing stopping them from divesting into growth stocks once they learn more and feel more comfortable with investing.
Conclusion
Instead of focusing on growth or dividend stocks, I think younger investors should learn to identify quality stocks first. Starting with quality dividend stocks help with learning while getting a stable income. Here are 3 important dividend investing concepts they can follow.
I think younger investors can be income or growth focused, but ultimately, they should look at the fundamentals of a business. If they like what they see, then they should look for opportunities to buy at fair or discounted valuations. Here are 5 important investing concepts they can follow.
Given a company that has no growth and one that grows, I generally prefer the latter, especially if it's showing both revenue and earnings growth.
Share your thoughts in the comments below
- Are you more focused on growth or dividends today? Why?
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Disclaimer: This article consists of my opinions and is for educational purposes only. Please do your own research and due diligence and consult a financial advisor and or tax professional if necessary before making any investment decisions.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
