It’s not usually the case that investors have an unlimited amount of money to pour into any stock that catches their eye. So let’s say that two hot stocks have popped on the radar. The first is a dividend share, offering a generous 8% dividend yield. The other is a growth stock that’s performing well and could have the potential to rally around 50% over the coming couple of years. Which one is the best option to buy?
The first consideration is the different timeframes involved. I’m going to assume that I’ve done my homework and have several reasons why I feel the growth stock could increase in value by 50% over the next two years. This could be based on the trajectory of earnings, the investment in the business, or other factors.
On the other hand, the dividend share yields 8% on an annual basis. It’s true that the future dividend per share can change, either higher or lower. So the yield going forward could be above or below 8%. I’m going to assume 8% for the time being.
This throws up an interesting comparison. It’ll take me over six years of accumulating the dividends in order to reach the same kind of return that I could get in two years from the growth stock. So ignoring all other points, from that angle it would make sense to take the shorter timeframe option, maximising the value of my money.
Likelihood of success
Nothing in the investment world is guaranteed. Yet some things are more likely than others. In this case, it relates to the certainty of dividends. If the 8% yield comes from a stock that has a consistent track record of paying out income, I’d say that the future return looks very achievable.
On the other hand, the future return of the growth share isn’t certain at all. These type of stocks are well known for share price volatility. They’re also very sensitive to investor sentiment. After all, the growth of the company depends on investors being optimistic about the future. If this changes, 50% could be just a dream.
Therefore, an investor might feel that the consistency of dividend income is more reliable than share price gains from the other stock.
The final point to weigh up is what the goal of the investor is. I’m happy to own stocks for either income or growth. Yet some have a specific goal that leans more towards picking one type of share or the other.
For example, younger investors often pick high-growth stocks. This is due to them often being in sectors that are popular right now. It also relates to the fact that they’re more risk-tolerant about investments than someone getting to retirement age.
Ultimately, there’s no right or wrong answer to the question. I’d probably buy the income stock based on the probability of getting the income. But I’d equally understand why another investor would pick the second option.