Investors Should Not Focus Too Much On Dividends

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Includes: AAPL, ALXN, AMZN, CF, DLTR, EW, NFLX, PCLN, REGN, SPY, UA
by: Aristofanis Papadatos

Summary

Many investors tend to put too much emphasis on dividends and thus miss a great number of promising stocks.

Young investors should not attribute too much significance to dividends.

The highest-growth stocks usually do not distribute a dividend, as it makes much more economic sense to reinvest all their profits on their business.

Many investors tend to put too much emphasis on dividends and thus miss a great number of promising stocks. For instance, when they have to choose between two stocks, they may pick the one with the slightly higher dividend yield even though the growth of the other stock may be more promising. However, while retirees are justified to focus on dividends, young investors should not attribute too much significance to them.

To be clear, this does not mean that investors should avoid stocks that pay generous dividends. Stocks like dividend aristocrats, which have paid a reliable, growing dividend for decades, have done so thanks to their consistent business performance. Therefore, investors can reasonably expect decent returns from these stocks. However, on the other hand, the best growth stocks typically pay a minimum or no dividend.

When a company is in a high-growth phase, it is only natural that it does not distribute a dividend. Instead it reinvests all its profits on the expansion of its business, as the latter has a great return on investment. As the company grows, it starts to decelerate and hence it may initiate a dividend at some point. At a later stage, when it becomes much more mature, the company is likely to boost its dividend payout, as it will not be able to invest all its earnings at a high rate of return. That's why some stocks, such as Green Mountain Coffee Roasters, plunge when they announce the initiation of a dividend. The cause of the plunge is not the aversion of investors to dividends. Instead the plunge results from the indication that the high-growth phase of the stock is in the past and hence slower growth should be expected after the initiation of a dividend.

Instead of focusing on dividends, investors should try to find stocks that have consistently grown at a high pace for years while they also have ample room for future growth. To make sure that these stocks have a solid business model, investors should also make sure that these companies have a minimum amount of debt. Companies that meet these 3 criteria are likely to offer exceptional returns.

The table below shows the 10-year return of the 10 best stocks of the last decade, which are Dollar Tree (NASDAQ:DLTR), CF Industries Holdings (NYSE:CF), Edwards Lifesciences (NYSE:EW), Under Armour (NYSE:UA), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Alexion Pharmaceuticals (NASDAQ:ALXN), Netflix (NASDAQ:NFLX), Regeneron Pharmaceuticals (NASDAQ:REGN) and Priceline (NASDAQ:PCLN). These returns become even more admirable if they are compared to the 66% return of S&P (NYSEARCA:SPY) during the same period.

Ticker

10-year return

DLTR

845%

CF

850%

EW

855%

UA

910%

AAPL

920%

AMZN

1576%

ALXN

1656%

NFLX

1970%

REGN

2490%

PCLN

5345%

SPY

66%

The most striking common feature of the 10 best stocks of the decade is that none of them, apart from Apple and CF Industrial Holdings, has ever paid a dividend. This fact only confirms the above mentioned pattern, i.e., that the most profitable companies reinvest all their earnings on their business, as this use of funds makes much more economical sense than distributing the earnings to the shareholders to deposit them in the bank for a lackluster return.

As mentioned earlier, in order to pinpoint the most promising growth stocks, investors should look for those that have exceptional and consistent growth record, minimum debt and ample room for future growth. The hardest part is to determine how many years of fast growth a company still has ahead. If growth has significantly decelerated in the last few years, then the company may be in the later stages of its growth phase. On the other hand, if there are no signs of fatigue, then the company is more likely to keep growing at recent rates for many years.

While investors should look for the above mentioned attributes, they should also realize that the above stocks require much closer monitoring than most other stocks. More specifically, these stocks tend to trade at elevated P/E ratios thanks to their high growth rates. Therefore, the slightest deceleration can cause their stock price to plunge due to a P/E contraction. Even a somewhat disappointing remark of the management regarding the future guidance may cause such stocks to plunge, before any negative sign shows up in the results. All in all, these stocks are pronouncedly sensitive to their growth rate. On the other hand, their high risk is justified by the exceptional returns they offer.

To sum up, many investors have an unjustified obsession for dividends and thus miss some high-growth stocks, which offer unique returns. Investors should keep in mind that most of the fastest-growing stocks do not pay a dividend or distribute a negligible one, as it is much more profitable for them to reinvest all their earnings on their business. Therefore, if a stock has solid growth prospects, minimum debt and a reasonable valuation, investors should not be deterred by the absence of a dividend.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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