Today, we will look at the difference between dividend and growth stocks. What do these two things mean? For most long investors, it is mainly a difference in expected returns over several years.
It depends. What matters is that a dividend stock should have lower combined returns than a similar growth stock, but a dividend stock is less susceptible to price fluctuations than a growth stock. A dividend stock behaves more like a bond than a growth stock and can be a good choice to go with high-flying stocks and bonds in a portfolio.
The bottom line for traders is that since investors receive some returns as cash directly from the company, price movement follows different patterns than a growth stock.
Table of Contents
Differences Between Dividend Versus Growth Stocks Introduction
Let’s quickly go through the rationale for issuing dividends. A company competes for investor cash against similar companies, with the company having the highest returns tending to attract more capital. That makes sense. When companies are private (like Koch Industries, for example), this is a very significant market force because, in general, investor cash goes directly into the company for use by the company as they see fit.
In the public markets, shares are traded between investors; cash is exchanged between investors, and the company’s capitalization does not change when these trades occur.
A firm will reinvest some earnings, leading to growth in stock price, and distribute some earnings as a dividend, depending on what the firm judges to be better, using various criteria. Therefore, a growth stock should be expected to trade in a wider range than a dividend stock, with some exceptions.
Dividend Stock Prices Are Sensitive to Reports
This is because earnings directly correlate to the amount of near-term dividends. This is not true for large firms that have been paying dividends for many years.
The firms have large cash holdings and want to pay the same quarterly dividend regardless of earnings. So, a dividend stock will likely experience price changes between earnings guidance and earnings reporting.
If earnings are lower than expected, the price should fall; if higher than expected, the price may rise. During the time leading up to earnings reporting, news about the firm can cause earnings expectations to rise or fall, leading to a price change.
Investors Value Companies With Dividends
The reason is the company has reduced its cash holdings and is less valuable. Any investor who buys a share the day before a dividend is announced will receive the dividend, and an investor who buys a share one day later will not.
This is why you may see prices rise into a dividend date on a stock chart. Expecting to pay a different price in these two situations is reasonable.
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Investors in Growth Stocks Depend on Other Investors
This means that factors unrelated to the company’s success or value are in play. Suppose positive news (like a cure for cancer) about a competing sector comes out one morning. In that case, a lot of investor cash will move into that sector, possibly temporarily lowering prices for other sectors.
If that is the day you choose to trade to take profits, you may have to take a lower price for your shares than you might have on a different day. Knowing support and resistance levels can help with this situation greatly.
Dividend Versus Growth Stock Differences Are Abundant
Another major difference between the two stock types is the market’s tolerance to volatility. If a dividend stock cuts its dividend for the first time in a long time, investors will react negatively.
If a growth stock misses targeted earnings, in many cases, the market barely notices. Dividend stocks starts trading in a wider range than expected, investors may be concerned, and the company may need to provide additional guidance.
If a growth stock starts trading in a different pattern or range, long-term investors will tend to shrug it off, and the company generally will not attempt to explain or influence the price.
Thus, volatility in price can be expected to happen for longer periods for growth stocks than for dividend stocks.
This also means that a growth stock can recover quickly from a significant price drop, while a dividend stock may face more resistance in recovering from a loss.
If you are following technical analysis, you might consider focusing on the price action on the chart.
Stock Signals & Alerts
What Is a Value Blend Growth?
Now consider a blended stock, that is, a stock that provides a dividend but also relies on growth. Such a stock would likely be a firm with multiple lines of business, some of which are mature and provide steady returns and some that are growing quickly. The firm will likely pay dividends from its mature lines of business and reinvest profits from its growth-oriented lines.
There Are Two Possibilities:
- First, the stock may trade in a blended way. Consider an ETF with two stocks: a growth stock and a dividend stock. The dividend stock’s contribution to the price of the ETF would behave like a dividend stock price, and the growth stock’s contribution to the ETF price would behave like a growth stock. Eliminating the pricing behavior of the ETF itself, the price of the ETF ought to fundamentally be the average of the prices of the two stocks. In this case, you could just think of the firm’s stock price as the sum of two other prices: Dividend-oriented and growth-oriented, with those prices changing naturally and independently.
- Second, the stock could change behaviors over time. A mature growth stock might announce new products at a certain time of year, leading to price changes reflecting the growth,h attributes. At other times of the year, the earnings and dividend announcements may have more effect, leading to price changes reflecting the dividend-paying attributes. Again, consider an ETF or two-stock portfolio. If one stock is Apple, the portfolio’s or ETF’s value will change in September, when Apple makes its annual announcements. If the other stock is Exxon-Mobil, whose dividends are significant, the portfolio will also change value during earnings seasons.
Final Thoughts: Differences Between Dividend Versus Growth Stocks
- Let’s recap the major differences between the two types of stock:
- Dividend stocks are easier to value because some returns are fundamentally predictable.
- Stock prices for dividend stocks are sensitive to news.
- Growth stock prices are sensitive to overall market activity.
- Dividend stocks have predictable price movements at certain times of the year.
- Growth stocks tend to trade in a wider range than dividend stocks.
We hope you enjoyed this post on dividend versus growth stocks. The Bullish Bears enjoys teaching our readers about different concepts in the stock market.
Be sure to check back for more posts focusing on the fundamental side of the market. The more you know as a trader or investor, the better.
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