When a company has grown to the point where it makes more money than it has good uses for, such as hiring more workers, spending more on research and development, buying another company, paying down debt, and so on, it may start paying a dividend to its shareholders. Not doing so means cash will just pile up, without being put to sufficiently productive use.
Those dividend payments are attractive to many investors, but some might want to bypass dividend stocks. Here are three reasons you might avoid dividend payers -- followed by a few even better reasons to do so.
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1. You don't want to receive regular infusions of cash
If you're not interested in having little (or big) cash payments appearing in your brokerage account regularly, steer clear of dividend payers. If you're thinking this way because you don't know what you'd do with that money, here are some ideas:
- Pay down any debt you have.
- Let it accumulate in your account until you spot stock(s) you're ready to buy.
- See if your brokerage will automatically reinvest those dividends in additional shares (or fractions of shares) of the stocks that paid them.
Don't think of these dividend payments as small potatoes, either. If you have a portfolio valued around $400,000 with an overall average dividend yield of, say, 3%, you've set yourself up to collect about $12,000 annually, or about $1,000 per month. That's powerful!
2. You don't like companies stable enough to pay dividends
You might be avoiding dividend-paying stocks because you imagine that they're mostly boring old companies, not likely to grow very quickly. That is a reason to avoid them, but it's not a good one. For one thing, many fast-growing companies these days pay some kind of dividend, and even if it's not a hefty one, it may be growing at a respectable clip.
Starbucks (SBUX 0.05%), for example, pays a dividend that recently sported a dividend yield of 1.7%, and it's still a rapidly growing business, with its fourth-quarter net revenue up 31% year over year and 538 net new stores opened. Its dividend, meanwhile, has been hiked by an annual average of 14% over the past five years. Over the past decade, its shares have grown in value more than fivefold -- an annual average of 20.3%. (And that's without even reinvesting dividends.)
Even sleepier-seeming dividend payers can be quite impressive, like Sherwin-Williams (NYSE: SHW). This 155-year-old company specializes in paint (and other coatings). Yawn, right? But its stock has grown at an average annual clip of 30% over the past decade with dividends not reinvested.
Think twice before bypassing dividend payers because of low expectations.
Image source: Getty Images.
3. You don't want to keep up with inflation
This reason is here just to make a point: One of the many wonderful things about dividend payers is that they can help you keep up with or exceed inflation. That's a big deal, because inflation can really shrink the value of your savings over time.
The rate of inflation has averaged around 3% over long periods, but it has occasionally been very high, even in double digits. Even if it averages 3%, that's enough to just about cut the purchasing power of your money in half over 25 years.
Since dividend payments tend to be increased over time, as long as the companies paying them remain healthy and growing, they aren't likely to see their purchasing power shrink. Many companies have been increasing their payouts at average annual rates of 5%, 10%, or more.
More things to consider with dividends
In case you didn't notice, these three reasons for avoiding dividend payers are facetious. Who wouldn't want regular infusions of cash or to keep up with inflation? (I hope this closer look at them sheds some light on how powerful dividend payers can be.)
Here are a few other things to consider:
- Dividends are not guaranteed: It's true that dividend payments are not guaranteed. Indeed, if a company falls on hard times, it may reduce, suspend, or even eliminate its payout, as plenty of companies have done. Companies try hard to avoid that, though, and often, you can see trouble coming.
- Growth stocks might grow faster: It's true that many growth stocks will grow at a much faster rate than dividend payers, but don't count dividend payers out. Many tech stocks, biotech stocks, and other stocks in fast-growing industries do pay dividends. And remember that sleepy little companies like paint specialists may quietly be growing at a faster rate than some high-profile businesses.
Overall, there are more compelling reasons to buy dividend-paying stocks than compelling reasons to avoid them. It's always good to have a balance in your portfolio, so you might include both dividend payers and nonpayers, along with some growth stocks and value stocks.
Alternatively, just make it easy on yourself and stick with low-cost index funds that will deliver close to the stock market's return. That can still grow your wealth at a good clip -- and a broad-market index fund will pay you dividends as well.
