The choice for me has always been between Dividend Growth and Dividend Income.
When most investors talk about investing for growth or income, they're usually talking about investing in companies with two different and distinct corporate strategies with two different perspectives toward their shareholders. The conversation usually ends up being an either/or conversation and opinions seem to polarize and differ quickly. It's a conversation I like to stay away from because I've already made up my mind and I'm solidly on the income side.
- Growth investing consists of identifying companies that have exhibited greater stock appreciation than the market overall and are expected to continue this amount of stock appreciation into the future. Growth companies generally retain all of their earnings for future expansion and therefore do not distribute any dividends to its shareholders. Investors are forced to buy and sell these stocks in order to receive compensation for their efforts.
- Income investing consists of identifying companies that retain a sufficient level of earnings to increase the business going forward but pay relatively high and regular dividend payments to their shareholders. Well established income stocks often have a long history of paying out dividends and an expectation that they will continue as well as increase in the years ahead. These are usually mature companies that have reached a certain size and are not able to sustain previous high levels of growth. They are also considered to be less risky investments.
When I'm looking for companies to invest in I'm generally screening the markets only for those companies that distribute a portion of their earnings to their shareholders in the form of dividends. Once I've finished, I divide the results of the screen into two categories. For the lack of any better terminology, I refer to these two categories as Dividend Growth and Dividend Income.
- Dividend Growth Companies are companies that pay out only a relatively small portion of their earnings in the form of dividends but they tend to increase their dividends over time. Hopefully these companies increase their dividend annually but at times that's not always possible. Those that can increase their dividends annually for an extended number of years will eventually be added to the list of Dividend Contenders, Dividend Aristocrats or Dividend Kings.
- Dividend Income Companies are those companies that pay out most of their earnings (90% and more!) in the form of dividends to their shareholders. These companies are usually Business Development Companies (NYSE:BDC), Master Limited Partnerships (NYSE:MLP), and Real Estate Investment Trusts (REIT).
Unlike many pure Dividend Growth Investors, I actually like and own both types of dividend producing companies but for different reasons. I own and continue to accumulate the dividend income companies for the sole reason that they throw off huge amounts of money (8-12% dividends) almost immediately. Many of these companies even pay their dividends on a monthly basis so I can reinvest and compound those monies very quickly. These dividends may not grow over time but the percentage that these dividends distribute more than compensates for that lack of growth.
Dividend growth companies are those companies that distribute a small percentage of their earnings and retain most of their earnings to grow and expand the business. Assuming that management is successful in growing the revenues and earnings of the business, these companies will more than likely increase their dividends annually over time. These companies generally have a dividend yield of only 1.5% - 3.0% but if successful, they will also have dividend growth rates in excess of the current rate of inflation (sometimes double and triple the rate of inflation). The result is that over time these dividends can grow phenomenally. The advantage of these stocks is that they will not only preserve an investor's purchasing power over time but will actually increase an investor's purchasing power in the future. Obviously this is important if an investor is looking to retire and live off those distributed dividends for many, many years.
Similar to the concept of "lifetime investing" where analysts will tell young people to buy growth stocks and older people to by income stocks, I feel that investors that have already decided that they are income investors should do something similar. I think that as a young person I should have bought dividend growth companies and as an older person I should buy dividend income companies. Either way, throughout my investing career, I should have only been in dividend producing companies (that seems so obvious now).
Today, as dividends are deposited into my accounts from various companies I'm confronted with the opportunity and the problem of deciding which type of dividend producing company I would like to invest in. Since dividends don't arrive in a large enough form or as quickly as I would like, the problem is often difficult for me. I like the dividend income companies because I know that by buying those types of companies, my dividend income next month and next quarter will be larger than if I had invested in dividend growth companies. On the other hand, by investing in dividend income companies I know that the dividend I receive will probably never grow and that almost immediately my purchasing power is eroding. It's a tough dilemma.
This problem of Dividend Growth or Dividend Income is a problem I always seem to struggle with each and every time I select a stock for purchase. I just don't currently receive enough dividends to live off of, nor do I receive enough dividends to grow my accounts at the rate I would like. It's a problem that I expect I will continue to struggle with for the rest of my life. But I also expect that eventually I will be successful. I wish others all the best in their own personal journey toward financial freedom and security. It's a tough road.
Good Luck and Good Trading.