Introduction to Dividend & Non-Dividend Stocks
Both dividend and non-dividend stocks have their place in any investor's portfolio, but they are also different in more ways.
Published May 12, 2024.
Understanding the difference between dividend and non-dividend stocks is the first step to a healthier portfolio and smarter investments.
A company may issue dividends (or not) depending on several factors:
- Company profitability
- Cash flow stability
- Future investment plans
While stable dividends have their place in securing investments, non-dividend stocks are important, too, but for different reasons.
Note: The information in this blog is purely educational and should NOT be considered advice.
What Are Dividend Stocks?
Dividend stocks are shares of companies that return a portion of their earnings to shareholders in the form of dividends. Dividends are typically distributed to shareholders quarterly, but some companies may also pay monthly, semi-annually, or annually.
Most dividend-paying companies, such as AT&T (T), Coca-Cola (KO), and Microsoft (MSFT), have a consistent record of earnings and cash flow.
These companies have been operating in relatively stable industries and possess a long track record of financial health, making their stocks generally less susceptible to sharp price swings. A consistent and growing dividend can indicate financial strength, whereas cuts may signal trouble.
Nevertheless, a company that doesn’t pay dividends isn't necessarily unstable. The decision to avoid dividends is not so much about stability as it is about future plans and the company’s relationship with the shareholders.
What Are Non-Dividend Stocks?
Non-dividend stocks do not pay dividends to shareholders, but they may still play an important role in growth-focused portfolios.
The companies that don't issue dividends mainly operate in sectors like technology, biotech, or renewable energy, with significant potential for future earnings growth. Examples include Amazon (AMZN), Alphabet (GOOGL), and Biogen Inc. (BIIB).
Since the company doesn’t pay out money to its shareholders, the remaining profits get reinvested into the company, potentially fueling growth and capital appreciation. However, the lack of dividend payments means that investors get their returns solely from the stock price difference, which can be highly sensitive to:
- Market changes
- Economic indicators
- Company performance
Return on Investment (ROI) With Dividend vs. Non-Dividend Stocks
Dividend stocks bring returns both from dividend payments and potential stock price increases. Non-dividend stocks rely solely on stock price appreciation for returns.
Investors usually find dividend stocks attractive for the stable income they generate. This type of income is appealing in stable or declining markets. Dividends can also be automatically reinvested, so investors can buy new shares with the dividend they received from the company.
Non-dividend stocks can still generate returns for investors through stock price appreciation. As the company grows and becomes more valuable, so does the investment.
Key Concepts and Terms for Understanding Dividend Stocks
Dividend Yield
A dividend yield is a percentage that shows how much a company pays out in dividends each year relative to its stock price:
Dividend yield = (Annual dividends per share) / (Price per share)
For example, if a company has a dividend yield of 10% and a share price of $1,000 with quarterly dividends, shareholders can expect a $25 dividend every 3 months (totalling $100 annually).
Dividend Payout Ratio
This ratio shows the dividends paid to shareholders relative to the company's net income. It is calculated as dividends per share divided by earnings per share (EPS).
A good dividend payout ratio is anywhere between 30-50%.
Dividend Date
The dividend date (or payment date) is the date when the dividend is paid to shareholders. The ex-dividend date is the cutoff day to be eligible for the next dividend payment. So, if you buy the stock on or after this day, you will not receive the upcoming dividend.
Key Concepts and Terms for Understanding Non-Dividend Stocks
The following terms apply to both non-dividend and dividend stocks:
Capital Gains
This parameter shows the increase in a stock's price from its purchase to its sale.
Non-dividend stocks often aim for capital gains as their primary source of investor returns, while dividend stocks provide returns through regular dividend payments and any potential capital gains.
Price-to-Earnings (P/E) Ratio
This metric is crucial for evaluating non-dividend stocks.
P/E ratio measures a company's current share price relative to its per-share earnings.
Growth stocks often have high P/E ratios since they expect their future earnings to grow. This shows that investors are willing to pay a premium for potential future potential profitability.
Beta
Beta measures a stock's volatility within the overall market.
Non-dividend (growth) stocks typically have a higher beta, which means they are more volatile and potentially riskier than dividend-paying stocks.
However, a higher beta also shows greater return potential.
Market Roles of Dividend vs. Non-Dividend Stocks
Dividend stocks are generally considered less volatile. They provide stable returns during economic downturns and can act as a hedge against economic uncertainty.
Non-dividend stocks are typically growth-oriented. They usually perform better during economic expansions when investors are optimistic about future earnings growth.
Market Volatility
In sideways markets (where the market neither goes up nor down too much), dividend stocks are the typical choice and the primary driver of potential profits.
During market downturns or periods of low interest rates, dividend stocks often outperform since investors seek income and stability.
In contrast, non-dividend (growth) stocks may perform better during bull markets and periods of economic expansion. In these cases, investors' enthusiasm and the potential price appreciation drive these stocks.
Predictable or Expanding: Should You Go for Dividend or Non-Dividend Stocks?
Both dividend and non-dividend stocks are potential additions to your investment portfolio. Usually, dividend stocks act as a safeguard in periods of volatile or sideways markets, whereas non-dividend stocks drive the expansion and potential profits in bull markets.
Luckily, you don't have to choose between the two and could be content with a mixture of both. The ratio in which you opt for either of those will depend on your investment strategy and whether you prefer a more conservative or growth-oriented approach.
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