The Most Unlikely Growth Stocks

What do you hope to get out of your dividend-paying stocks? The answer will undoubtedly vary from investor to investor. After all, there are many uses for the cash that dividend stocks put in your pocket, and a basket of dividend-payers may also help reduce portfolio volatility.

But this doesn't mean that dividend-paying stocks are necessarily slow growers. On the contrary, some of the market's monster performers over the past 10 years have paid regular dividends.

Consider:

And those numbers aren't out of the norm. According to Capital IQ, fully 42% (226 of 538) of dividend-paying stocks capitalized above $1 billion in June 1997 are up more than 100%.

Now, you might be scratching your head at this data. But as a 2003 study by Robert Arnott and Clifford Asness showed, there's a link between higher dividend payouts and higher earnings growth.

Say what?!
Now, traditional financial logic says that the more cash a business pays out to its shareholders, the less it has left to reinvest in the business. And that's absolutely true, but what if management has too much cash?

Some large-cap growth companies, such as Dell (NASDAQ:DELL), for example, are sitting on mountains of cash, but don't give any of it back to shareholders in the form of dividends. Investors in these stocks are instead putting all of their faith in management's ability to do more with that cash than they could. Can Dell management consistently invest your cash into projects returning 10% or more annually? Possibly, but such feats are easier said than done.   

On the other hand, as Motley Fool Income Investor advisor James Early recently noted, dividends can "force managers to allocate capital efficiently." Because managers of dividend-paying companies naturally have less cash on hand, they must be more selective with the projects they take on, rather than indiscriminately spending on lackluster ventures or allowing excess cash to pile up on the balance sheet.

The best of both worlds
This is the sort of thing shareholders love: efficient management maximizing the firm's value while returning some of the company's profits in the form of cold, hard cash. Plus, with that cash in hand, you can buy more shares of the company or invest it somewhere else. Regardless, the choice is yours -- not anyone else's.

If you're interested in finding some quality dividend-paying stocks to add to your portfolio, consider a free 30-day trial to Income Investor. In addition to receiving two new picks each month, you'll get full access to all of the past recommendations and the extensive research that goes along with them. Simply click here to start your free trial.

This article was originally published on April 13, 2007. It has been updated.

Todd Wenning could use a 3-Way from Skyline Chili in Cincinnati right about now. He does not own shares in any company mentioned. Dell is both a Stock Advisor and Inside Value pick. The Fool is investors writing for investors.