• Create BookmarkCreate Bookmark
  • Create Note or TagCreate Note or Tag
  • PrintPrint

Core of the Story

When you buy a stock, your potential return comes from two sources. The first is the dividend that you expect the stock to pay over time, and the second is the expected price appreciation you see in the stock. The dividends you will receive from investing in stocks will generally be lower than what you would have earned as coupons if you had invested the same amount in bonds; this sets up the classic tradeoff between bonds and stocks. You earn much higher current income on a bond, but your potential for price appreciation is much greater with equity. Bonds are less risky but equities offer higher expected returns. But what if you could find stocks that deliver dividends that are comparable to the coupons paid on bonds? Two different arguments are made by those who believe that such stocks are good investments.

  • Optimist Pitch: “You have the best of both worlds”: In this pitch, you are told that you can get the best of both bond and equity investments when you buy high dividend stocks. Summarizing the pitch: These are stocks that deliver dividends that are comparable and, in some cases, higher than coupons on bonds. Buy these stocks and you can count on receiving the dividends for the long term. If the stock price goes up, it is an added bonus. If it does not, you still earn more in dividends than you would have earned by investing in bonds. In fact, this story is bolstered by the fact that many stocks that pay high dividends are safer, larger companies for which the potential risk is low.

  • Pessimist Pitch: “Defensive investments”: This is the pitch that gains resonance in bear markets. In an environment in which investors have seen their equity portfolios wither as the stock market declines, stocks that pay high dividends offer solace. Summarizing this argument: Even though these stocks may lose value like other stocks, investors holding on to them can still count on receiving the dividends. In fact, during crises, a general flight to safety occurs across all markets. While it manifests itself immediately as a shift from stocks to government bonds, it also shows up within equity markets as investors shift from higher-risk stocks (often high growth companies that pay no or little dividends) to low-risk stocks (often stable companies that pay high dividends).


PREVIEW

                                                                          

Not a subscriber?

Start A Free Trial


  
  • Creative Edge
  • Create BookmarkCreate Bookmark
  • Create Note or TagCreate Note or Tag
  • PrintPrint