Why Dividend-Growing Stocks Are Better Than High Dividend-Yielding Stocks
- Erik James Roberts, Founder & Chief Investment Officer | Infinitus Wealth Management
- Oct 13, 2023
- 4 min read
Dividends have long been the focal point for income-focused investors. They offer consistent payouts from investments and can serve as a reliable income stream, especially for retirees. Two types of dividend-paying stocks are particularly popular: high dividend-yielding stocks and dividend-growing stocks. While the former may seem more attractive at first glance due to their generous yields, the latter often presents a more compelling long-term opportunity. In this article, we'll delve into the reasons why dividend-growing stocks may outshine their high-yielding counterparts.
Sustainability of Dividends
High Dividend-Yielding Stocks: Stocks that sport high dividend yields may not always be sustainable. A high dividend yield can sometimes result from a falling stock price, which may indicate underlying problems in the company. If a company is struggling with its core operations or facing headwinds in its industry, it may cut or eliminate its dividend in the future.
Dividend-Growing Stocks: These are stocks where the company regularly increases its dividend. A company that consistently grows its dividend is often one with strong financial health and a positive outlook for future earnings. The consistent growth of dividends indicates management's confidence in the company's future and its commitment to returning capital to shareholders.
Capital Appreciation Potential
High Dividend-Yielding Stocks: While these stocks offer a higher immediate yield, they often have limited capital appreciation potential. Companies paying out a large portion of their earnings as dividends may not be reinvesting sufficiently into the business to fuel growth.
Dividend-Growing Stocks: Companies that steadily increase dividends often see steady stock price appreciation. This is because dividend growth usually indicates a healthy, growing business. Over time, this can result in significant total returns (capital appreciation + dividends) for investors.
Inflation Protection
High Dividend-Yielding Stocks: A static high dividend does not offer protection against inflation. Over time, the purchasing power of the dividends can diminish if they do not grow.
Dividend-Growing Stocks: One of the significant advantages of dividend-growing stocks is that the rising dividend can help offset the erosive effects of inflation. As dividends increase, they preserve – and can even enhance – the purchasing power of the income received.
Sign of Business Quality
High Dividend-Yielding Stocks: A high dividend yield alone does not signify a quality business. As previously mentioned, a high yield might be due to a declining stock price, hinting at issues with the company.
Dividend-Growing Stocks: Regularly increasing dividends are often a hallmark of well-run companies with durable competitive advantages. Such companies generate steady free cash flow and have the confidence to share an increasing portion of their profits with shareholders.
Reinvestment Opportunities
High Dividend-Yielding Stocks: The high immediate income might discourage some investors from reinvesting their dividends, opting instead to spend the payouts.
Dividend-Growing Stocks: The power of compounding becomes evident when dividends are reinvested, especially with dividend-growing stocks. As dividends increase and shares are purchased with those growing dividends, the potential for exponential wealth growth over time is significant.
Tax Considerations
High Dividend-Yielding Stocks: In many tax systems, dividend income is taxed differently than capital gains. High dividend yields might expose investors to higher immediate tax liabilities.
Dividend-Growing Stocks: Investors in dividend-growing stocks might benefit from a combination of capital appreciation (often taxed favorably as long-term capital gains) and gradually increasing dividend income. This mix can be more tax-efficient in certain jurisdictions.
Summary
While high dividend-yielding stocks have their place in an income-focused portfolio, especially for those seeking immediate cash flow, dividend-growing stocks often present a more balanced opportunity for both income and growth. Through a combination of sustainability, inflation protection, and the potential for capital appreciation, these stocks can offer long-term investors a compelling case for inclusion in diversified portfolios.
At Infinitus Wealth Management, we offer a complimentary, no-obligation portfolio review for investors who want an independent fiduciary second opinion on how their capital is actually being managed.This is a conversation, not a sales process. If your portfolio is already well constructed, we will say so directly. If we identify avoidable costs, unnecessary concentration, tax inefficiencies, or portfolio structure that may be working against you, we will show you specifically where those issues exist. From there, you decide what to do with the information.
Important Disclosures
Infinitus Wealth Management is a registered investment advisory firm. This article is provided for educational and informational purposes only and does not constitute investment, tax, legal, or accounting advice. It is not an offer or solicitation to buy or sell any security or to enter into any advisory relationship. Any references to specific strategies, withdrawal rates, tax provisions, or historical figures are general in nature and may not be appropriate for any individual investor.
Past performance is not indicative of future results. All investing involves risk, including the possible loss of principal. Tax laws are complex, change frequently, and have unique application to individual circumstances; please consult a qualified tax professional regarding your specific situation. Social Security rules, Medicare rules, and retirement account regulations are subject to legislative and regulatory change.
The information in this article was believed to be accurate at the time of writing but is not guaranteed. Readers should consult with their own qualified advisors before making any financial decisions specific to their situation.
