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Dividends or Growth - Do You Have To Choose? |
by John Jagerson
Note: If you aren't familiar with the concept of dividends, be sure to read What Are Stock Dividends for information and examples.
Prior to the 1980's it was common to assume that a stock's value was derived from the discounted total of estimated future dividend payments. However, in the 1980s and 1990s alternative theories arose and there is still significant questions about whether changes in the estimates of future dividend payments can fully explain the volatility of a stock's price. There are still a lot of questions about what really drives prices. 
The change in attitudes about the value of dividends during this period has attached a stigma to investors looking for dividend paying stocks. The counter argument is often centers on how much better it would be to look for "growth" stocks over those paying a dividend.
This argument is not actually valid. In fact some diversified indexes of dividend paying stocks such as the Dow Jones Select Dividend Index would have outperformed the S&P and the Russell 2000 (small cap) index by almost 100% over the last 10 years. Even compared to other growth indexes, dividend paying stocks outperformed based on lower volatility to returns.
Perhaps deciding between a dividend paying portfolio of stocks and a growth oriented portfolio is not a decision that has to be made. It seems entirely reasonable that income and growth can and does exist side by side. In other words following the wisdom of those financiers that came before the boom in quantitative analysis in the 80's may pay real dividends!
There are multiple ways to approach developing a part of your portfolio like this. It is possible to search for and pick individual stocks and add them to a diversified list but it may be easier to just buy an ETF that trades an index based on dividend paying stocks like the iShares dividend index fund (DVY). For traders looking for opportunities to take more risk a dividend indexed ETF could be just the ticket by using options on the index to offset risk, speculate and leverage the trend.
In an earlier article I discussed the similarities between stocks issuing buyback plans to those paying dividends. To learn more about those and how to find them - click here.
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