When it comes to investment strategies, ‘growth’ and ‘income’ investors tend to focus on very different things. For growth investors, it’s often the case that sales and earnings are more important than dividend payouts. But it’s worth remembering that dividend track records can tell you a lot about a company’s growth and outlook - and not just how much cash is finding its way back into shareholder pockets.
Jim Slater, the famous British growth investor, wrote in his 1992 book The Zulu Principle, that he preferred companies that pay a dividend. Slater was a dyed-in-the-wool growth investor, but here he was stating the case for dividends. He explained: “...the dividend payment and forecast (if any) to some extent corroborate the management's confidence in the future. The ideal company will have a steadily increasing dividend growing broadly in line with earnings.”
What he was saying was that the dividend was a useful extra way of figuring out whether a company’s growth was likely to continue. Yet some growth investing strategies actually see dividends as a negative.
Indeed, a traditional view of companies that pay cash back to investors is that they’ve simply run out of ideas. They don’t know how to grow any further and may have gone ex-growth. More generally, there’s an assumption by growth investors that dividend paying stocks actually deliver lower portfolio returns. They can’t deliver the capital growth that fast moving growth stocks are known for.
But none of this is necessarily true. Research shows that higher yielding stocks can actually deliver superior portfolio returns over time.
The power of dividends
In his book Behavioural Portfolio Management, the investor and academic Dr C. Thomas Howard makes the case for high yielding stocks not only outperforming but also producing lower portfolio volatility. He argues that they do better, with fewer stomach-churning swings.
To understand what it is about dividends that makes them so useful, it’s worth considering the credibility of all the other ways that management teams signal their confidence to the market.
One of the most common of these, of course, is forecasts. Dr Howard notes that management forecasts and projections are often far too optimistic. A second source of management confidence comes in financial results and routine earnings updates, but again, these are either externally audited or bound by strict market rules. That means it can be hard to decipher whether management…
