Stocks for income: High yield or dividend growth?

Low interest rates have caused some income investors to consider other asset classes outside of bonds in their search for yield, including dividend-paying stocks.

Yet investors looking at dividend stocks for income often run into a dilemma: Should they focus on companies with high current dividend yields, or companies that have the potential to grow dividends in the future?


Dividend vs. Yield

Right now, there is a case to be made for dividend growers over the highest yielders.

First, some argue that the stocks with the biggest dividend yields are historically expensive due to income investors chasing yield in recent years and pushing valuations higher.

Also, Barron’s recently reported that investors hunting for juicy dividend yields have limited options among U.S. large-cap stocks, pointing out that only 13 companies in the S&P 500 have dividend yields over 5%.

Jack Hough at Barron’s wrote:

“Patient investors open more options: 170 companies now pay 5% yields calculated against what it cost to buy their shares five years ago. Also, a giant yield can be a signal that investors doubt a company’s ability to grow or even sustain its payments … There are two more big reasons to favor dividend growers over high-yielders: the growers are relatively cheap, and they tend to fare better when interest rates rise, as many on Wall Street expect they will.

Choice Examples

There are several portfolios on Covestor’s marketplace of investment managers that focus on dividend growth stocks.

  • Dividend Growth Portfolio managed by Sizemore Capital – The portfolio is concentrated among asset classes that have a history of rising income payouts. The primary objective of the portfolio is to potentially generate a high and growing income stream that will outpace inflation over time. Sizemore attempts to identify investments that have a long history of rising income, or the potential to rise going forward. Research attempts to gauge the safety of the income stream and seeks to avoid positions where the risks outweigh the potential for high yields.

  • Sustainable Dividend Growth Portfolio managed by Hrvoje Sajkovic – Mainly invests in high yield stocks with a two-year history of consistent dividend payouts.

  • Dividend and Income Plus Portfolio managed by Bill DeShurko/401 Advisor – Manager attempts to buy high-yielding securities that research suggests have the financial ability to maintain and possibly raise dividends.

Of course, income investors looking to equity-like sectors for yield need to keep in mind that stocks and REITs can potentially have different risks and more volatility than bonds.

Continue learning: How to balance yield and risk in your income portfolio

Photo Credit: Alex E. Proimos

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. All investments involve risk, the amount of which may vary significantly. Dividends reflect past performance and there is no guarantee they will continue to be paid. Past performance is no guarantee of future results.