Here is a question:
‘Is Growth Investing Better than Dividend Investing?’
This is an age-old debate as to which of the two value investing styles is ‘better’ in its ability to generate returns to investors. Some perceive growth investing to be better as they believe that they may achieve better capital gains from it than dividend investing. To a certain extent, some believe that dividend investing is a slow method of building wealth in the stock market.
So, is this belief or perception true?
Well, in this write-up, I’ll discuss the similarities and the key difference between dividend investing and growth investing. Then, I’ll list down a couple of criterias that you may consider when deciding which style is best suitable for yourself.
#1: The Similarities
First, dividend and growth investing are subsets of value investing and thus, will place great emphasis on a stock’s fundamentals before investing.
Both dividend and growth investors would assess the quality of stocks based on their ability to deliver growth in sales, earnings, and cash flows for the long run. Both of them like to invest and accumulate their stocks if they are undervalued.
Thus, let me reiterate that if you come across an individual who claims to invest for growth and he does not study the stocks’ annual reports before buying their shares, it is almost certain that he is not a growth investor. He is one who is just trying his luck in trading or speculating stocks in the stock market.
So, please do make a distinction between a growth investor and others who are trying to trade or speculate their way to stock market riches.
#2: The Key Difference
While both investors emphasize a stock’s sales, profits and cash flows, the main difference lies in their preference as to how the stock wishes to use its earnings and cash flows to benefit its shareholders.
Dividend investors prefer to receive more dividends from a stock’s earnings and cash flow. Growth investors prefer a stock that reinvests its earnings and as well as cash flow to sustain business growth in the future.
To put into perspective, let’s say we have A Ltd and B Ltd. Both stocks have solid fundamentals and they reported $100 million in earnings in a year.
A Ltd chooses to pay out $80 million to its shareholders in dividends and hence, retaining $20 million of its earnings for reinvestment.
B Ltd chooses to pay out $20 million to its shareholders in dividends and hence, retaining $80 million of its earnings for reinvestment.
Thus, dividend investors would choose A Ltd over B Ltd.
Meanwhile, growth investors would choose B Ltd over A Ltd.
As such, growth investors would study a stock’s balance sheet and statement of cash flows in great detail to find out if it has the financial capability to invest for the future. In addition, growth investors would find out what the initiatives that the stock is undertaking today to grow its business in the next 2-3 years.
But, with that being said, it is not accurate to say that dividend investors do not study such things too. They do.
The difference between the two investors are:
Dividend Investors:
– Want more proportion of earnings to be paid to them in dividends.
– Want less proportion of earnings to be reinvested for growth.
Growth Investors:
– Want more proportion of earnings to be reinvested for growth.
– Want less proportion of earnings to be paid to them in dividends.
#3: Which of the Two Investing Styles Should I Choose?
Should I choose dividend investing or growth investing?
Here, if you are undecided, you may refer to my list of criterias as a reference in guiding you to make a better choice between the two value investing styles. Let me start with dividend investing. Personally, I believe dividend investing is more suitable for you if:
1. You are a Beginner
This allows you to build much needed initial confidence as you focus on earning your first few dividends from a portfolio of solid dividend stocks. Imagine, if you wish to focus on capital gains right from the start and you failed to do so for the first 5-10 stocks you bought, you may get demoralised.
2. You Want to Earn Passive Income
You like the idea of receiving recurring dividends from your stocks, regardless of their stock price movements, be it up or down. You can even build a portfolio in such a way where you’ll collect dividends in 8-9 months out of 12 months every single year.
3. You Like to Keep Investment Simple
This can be done by investing in stocks where their business models are simple.
4. You Like to Choose How to Use Your Dividends Collected
You like to have the option to either spend or reinvest your dividends received.
On the other hand, I believe growth investing is more suitable if:
1. You are Patient
Many expect stock prices to grow quickly after purchasing them as they believe that they could enjoy faster capital appreciation from growth stocks. But, here’s a question, ‘What if they bought a stock like Alibaba at HK$ 200+ a share?’’How would they react after they saw its stock price fall quickly to HK$ 150+ a share?’ Can you wait for stock prices of a growth stock to recover and appreciate in line with its business growth? If you can, growth investing is suitable for you.
2. You Want to Invest in the US Stock Market
Dividends from US stocks will be subjected to a 30% withholding tax. It is better to practise growth investing for US stocks for it makes more financial sense. The markets suitable for dividend investing would be Malaysia, Singapore and Hong Kong as these countries have friendlier tax structures for dividend investors.
3. You are a Visionary
You would need to be more forward-thinking and be a visionary, when studying and assessing growth stocks. This is because growth stocks tend to have a more enterprising management team that are driven for growth. They tend to try out new things and be innovative. So, this style of investing is suitable for you if you share similar values with the stocks that you wish to invest into.
4. You Like to Compound Wealth
You don’t mind not receiving any dividends as long as you know that the stock’s earnings are reinvested wisely to compound shareholders’ wealth.
Conclusion:
So, which of the two styles are suitable for you?
That, I’ll leave it to you to decide based on your preference and experiences. As for myself, I’ll consider myself to be a dividend investor at core. This is because I enjoy collecting dividends regularly from all stocks in my portfolio. I can use the dividends collected to pay bills but as of now, I reinvested them to further grow my dividend income.
Alright, that is it for this week.
If you have any questions / feedback, please post them to ian@kclau.com.
