Strike a Balance with Innovative Stocks and Dividend Stocks

Over the long run, dividend stocks have had very attractive total returns, averaging 9% annually. This has made drip investing (dividend reinvestment plans) quite popular. Stocks with drip allow an investor to automatically reinvest the dividends they receive into buying additional shares. But lately the returns from innovative stocks and disruptive stocks deemed as growth stocks have far outpaced dividends stocks.

So which type of stocks are better for you as an investor? The comparison of dividend vs growth stocks is important to your financial returns as we explore the two alternatives.

A Balance of Dividend Stocks

Many investors in dividend stocks would readily accept a 9% return from the “average” dividend stock over the long run. Dividend stocks are attractive because they pay a current amount of income in the form of dividends, plus you get price appreciation on the share price. The combination of these two can lead to an attractive total return. Remember that if you own a stock with price appreciates of 6%, and its dividend yields 3%, you’ve got a total return of 9%.

It is the attractiveness of these total returns on dividend stocks that have made drip investing so popular in recent years. Stocks with drip allow you to automatically reinvest the dividend income received to buy shares of the company stock to increase your holdings. Drip programs offer a great way to slowly increase the number of shares you own in a company and to correspondingly increase your dividend income.

Here is what we see as the attractiveness of dividend stocks right now:

• You get paid while you hold the stock of the business. Current income in the form of dividends from a stock or mutual fund is attractive, especially for those investors at or near retirement age. Getting a periodic dividend payout assures you at least some return on your investment, even if the stock price does not increase.

• Dividend stocks tend to be more mature companies that generally are safer to invest in vs. many growth stocks. We are not saying that all dividend stocks are safe, but the businesses underlying dividend paying stocks in total tend to be more profitable and mature, where their products have been accepted by the marketplace over time.

• Dividends can be increased over time. A dividend investing strategy centered around buying stock of companies that regularly increase their dividends can lead to great returns on your investment capital.

There are a few potential pitfalls to watch for with dividend paying stocks:

• Dividends are declared at the discretion of the company’s Board of Directors. So if you don’t look for companies that regularly pay and increase their dividend you may get surprised if a dividend is paused or eliminated by the business.

• Make sure the business can afford to pay its dividend. Companies with too high a dividend payout ratio (say above 60%) are an indication that the business is in jeopardy of not being able to afford its dividend going forward. Also, companies with too much debt on its balance sheet are similarly in jeopardy of possibly cutting or suspending their dividend. This is because debt holders need to get paid before any dividends are declared.

If you are looking for a high-quality dividend stock, consider Dominion Energy (ticker D). Dominion Energy is one of the largest regulated electricity utilities in the United States, with a market capitalization of approximately $60 billion. The stock currently yields 3.5% and I would expect that to increase 5% to 6% annually, in line with profit growth.

A Balance of Innovative Stocks

Innovative stocks have been on quite a tear the last couple years, led by the technology sector.

These growth companies are defined as a business that is growing revenues and earnings faster than the stock market averages. This is particularly true when looking at future long term growth opportunities. Given the growth in the use of technology worldwide it is not surprising that innovation stocks and disruptive stocks in the technology sector are leading the way for growth stocks.

Think of innovation stocks and disruptive stocks as those companies that are challenging the status quo of how things are done. A few examples of innovations stocks and disruptive stocks are:

Zillow – challenging the way we look for and buy homes

DocuSign – challenging the way we sign and save and share documents

Zoom – changing the way we stay connected with co-workers and loved ones

These growth stocks are usually valued by metrics other than the traditional metrics around price-earnings ratios, etc. Often, they are valued as a multiple of sale. This is because many of these kinds of companies are in their early stages, where they are investing for future mega-growth, and therefore do not have profits yet. In these cases, investors are trying to determine just how big the addressable market is for the business and how fast the growth company can obtain a large chunk of related revenue.

Here is what makes innovative stocks attractive right now:

• Companies with high revenue growth rates, say greater than 50% year to year, are in high demand. This can lead to large capital appreciation on your investment if the company continues to perform well. The three companies listed above have each had their stock price more than double over the last 12 months.

• Unlike dividend income where you need to pay taxes as you receive the income, you don’t pay taxes on the appreciation of the share prices until you sell the shares. As such, investing in successful growth stocks can be a very tax efficient way to compound your wealth.

• Many of the successful growth stocks are in the technology sector and we don’t see that industry slowing down any time soon. We still seem to be in the early stages of digitizing our lives.

Here are a few things to watch out for when investing in growth stocks:

• Slowing revenue growth. Growth stocks can be richly valued as long as the business metrics continue to perform well. However, if a growth business starts to decelerate its revenue growth, there will be a revaluation of the stock price, that can sometimes be severe.

• Volatility in stock price. Given the high valuations of growth stocks and the fact that many growth stocks do not pay a dividend to support the stock price, you will find that many growth stocks are quite volatile on week-to-week basis. This can be unnerving at times, particularly if the stock price direction is down, but use the volatility on the downside to pick up a few shares on the cheap. You will be pleased with your returns when the stock price bounces back.

Summary

Depending on your investing strategy, either dividend stocks or growth stocks can be right for your portfolio.

And it is fine to mix and match. You can select some high-quality dividend payers to act as a ballast to your portfolio and sprinkle in some growth stocks to try and super charge your returns.

Innovative stocks and disruptive stocks are currently quite popular, so invest slowly in these kinds of companies to maximize your returns.

Use the four examples of dividend stocks and growth stocks discussed above to help you get started with your research.