Young investors are often swept up in growth-only investing, and while that style does have potential for massive returns, it also has the more likely outcome for some rough sailing.
In this clip from the Market Foolery podcast, Chris Hill, Bill Mann, and Bill Barker explain why some people are against dividends as a concept, but why diversifying your portfolio with dividend stocks is a wise move for young investors as well as old.
A full transcript follows the video.
This podcast was recorded on April 13, 2016.
Chris Hill: @MarketFoolery is our Twitter handle; you can hit us up with questions there. I got a question from Stukat31, who asked: "Do you think dividend stocks for a young investor is wise?" None of us are young investors.
Bill Mann: Why do you have to go there?
Hill: I'm just saying ...
Mann: That's mean!
Bill Barker: Is it because we're on video today and we can't hide the fact?
Hill: Um ...
Barker: Whereas, normally, the listeners could entertain the notion that we're -- we need stunt doubles.
Hill: Do you think that's happening? Do you think there are listeners who have heard this podcast over the past few years, and thought, "Oh yeah, those three guys, they're easily in their 20s."
Barker: Hope so.
Mann: Yes, the answer is yes.
Hill: The question remains.
Barker: [laughs] The mystery is gone now.
Barker: Not that we're advocating that anybody watch the video.
Hill: No. But, if you are in your 20s or 30s, does that make sense?
Mann: I'll be honest. I don't really care about dividends.
Hill: And you've been investing since your 20s, so I'm assuming, when you were in your 20s, you were like, "No."
Mann: Eh, I mean, there is a theory, and we're going to start talking financial theory, so this is fantastic for a podcast.
Hill: Honey, come quick!
Mann: Yeah, run on in! The dividend irrelevance theory, which is really what I want from a business, that they do good things with their capital. If they don't have good things to do with their capital, returning it to shareholders through buybacks or dividends is perfectly legitimate. But whether a company pays a dividend or not, for me, is largely not that relevant. I mean, I think it becomes relevant for people as they grow older and would like a stream of cash coming back to them in a fairly tax-efficient way. But, buy good companies. Whether they pay dividends or not doesn't matter all that much.
Barker: So young investors should not exclude dividend-paying stocks, because there are many great ones, and it is part of a complete portfolio to have companies that are not all taking all of their money and investing it in growth. If that's your entire portfolio, I hope you're young, because --
Mann: Because you're going to visit some places.
Barker: Yeah, there are times when that's going to go wrong. But that's how many young people might think they are supposed to invest, is -- buy some explosive growth things, because if they explode, then you've got 30, 40, 50 years left to make the money back, which is true, and it is a reason to take on more risk when you're young. But, a lot of the great companies out there have been around for 40, 50, 80, 100 years, and don't need to take all of their profits and constantly try to grow the business at explosive rates.
So paying a dividend imposes a certain amount of discipline, and it relieves management of some of the pressure of constantly looking for ways to keep the growth machine going. Say you've got a payout ratio of 40%. You're paying out 40% of your profits every year to shareholders. You've only got to figure out what to do with the other 60%. That's easier on management than taking 100% of the profits every year and saying, "How do we keep this high growth equation going?" So there are a lot of great companies that pay dividends, and absolutely, young investors should be looking for not just big, risky bets, but great companies of all stripes.
Hill: But, I think that's one of the things that's changed over the last 15 years or so, is the perception of dividend stocks. I just remember, when I first started investing, and I was in my 20s --
Mann: So you've changed in 15 years, the perception!
Hill: No, I think the perception of dividend stocks was, big, stodgy, unimaginative, and almost completely lacking in growth. And we've seen plenty of examples over the last decade of companies that are able to establish healthy growth patterns, have market-beating returns, and oh, by the way, they also pay a dividend.
Mann: Yeah, that's Costco (NASDAQ:COST). What you've described is Costco. And I remember suggesting, I guess, 15 years ago now that Costco was one of the most innovative companies in America. "They're not a dot-com, they're not doing really cool things, they're not from Northern California, how could they possibly be innovative?" And I do actually, to Bill's point, think that having a dividend and having a statutory dividend does give companies some discipline.
And if you were to ask me if I wanted a slate of dividend-paying stocks versus a slate of mega-high-growth stocks, I'd take the dividend stocks every time. Every time.
Barker: The best stock over the last 40 or 50 years, I don't think it really matters what time period you're talking about, it's Philip Morris (NYSE:PM). That has been paying dividends all the way. That equation assumes you took the dividends and reinvested it in the stock, etc. But many of the great growth stocks over the last 40 or 50 years have paid dividends all the way. And then you need to reinvest the dividends for the maximum return on that kind of investment.