Dividend or growth stocks: income now or capital later?

Where a share’s return comes from – and why a dividend is not a gift

A dividend is often compared with rent from a property, but the difference is fundamental. Rent comes from a tenant; a dividend is a slice of the company’s accumulated profit that it separates from itself and hands to shareholders. A company can do one of two things with its profit: reinvest it in the business or distribute it. If it cannot reinvest at the return the market expects, it makes more sense to give the money back to its owners.

Take, for example, a restaurant worth €100,000 that makes €10,000 of profit in a year. Whether the owner takes the money out or leaves it in the business, they have €110,000 in total – an asset plus cash, or simply a larger asset. Shares work the same way: when a dividend of, say, €5 is paid, the share price normally adjusts down by about €5. On any given day the fall may be slightly smaller or larger because of news or wider market moves, but over time the relationship holds. A dividend is not a free lunch; it simply redistributes value.

That is why, in Kliment Robev’s view, the key measure of an investment is total return: the rise in the share price plus any dividend. A company paying a 5% dividend whose shares fall 7% is a worse deal than one that pays nothing but whose shares rise 6%. A dividend payer and a growth company are often the same business at different stages of its life – a mature company with little room left to grow becomes a “money box” that hands out cash.

Passive income from dividends: how much capital do you need?

Suppose the goal is €1,000 a month, or €12,000 a year. Invested in a broad index that tracks the whole market, with a dividend yield of, for example, around 1.5%, you would need roughly €800,000. With selected dividend-focused companies, or a fund yielding around 3–3.5%, the figure falls by more than half, to about €340,000. These are illustrations only, as yields change with the market. Dividend payers yielding 3–4% also tend to offer limited price growth, so the trade-off is between income today and accumulation.

Income does not have to come from dividends alone. A distributing fund pays out the dividends it receives, while an accumulating fund reinvests them and lets compounding do its work; with the latter, income can come from periodically selling a small part of the holding – €1,000 at a time, for example. The tax treatment of the two may differ and depends on your personal circumstances, so it is worth checking beforehand.

Dividend stocks are not immune to falls either: they also lose value when the market starts to demand a higher return for the risk. Still, dividends have real advantages, many of them psychological:

• They reassure: regular payments make it easier to hold on in a crisis rather than sell in a panic.
• If the company maintains its dividend, the income continues even when the portfolio’s market value drops for a while – from €340,000 to €240,000, for instance.
• A company paying out real cash finds it harder to dress up its earnings.
• Later in life you can live off the dividends without selling assets, and the portfolio can pass to your children.

The high dividend yield trap

Companies with dividend yields of 9–10% do exist, and the temptation is obvious: a handful of them looks like a short cut to passive income with less capital. But a high yield arises in one of two ways – either the company has sharply raised its dividend, which is rare, or its share price has collapsed, which is the usual case. And when the market punishes a company, one of management’s first decisions is often to cut the dividend. An investor who picked a share for its 8–10% yield then finds one day that it has become 3–4%, and the income plan no longer works.

Back to the restaurant: if it makes just €150 instead of €10,000, but the owner is used to receiving 10%, the manager is left with poor options. Borrowing to keep paying is a road to nowhere, because part of the business’s value is then owed to the bank. Cutting costs may lose the good chef, and then the guests. Either way, the value falls. The market usually reads these signals early from the financial results and cash flow, so if something looks too good to be true, it is more likely a trap than an opportunity everyone else has missed.

How to recognise a quality dividend

A high yield is not a criterion in itself – what matters is whether the dividend is sustainable. If you would rather not analyse cash flows and ratios yourself, a simpler route can be an exchange-traded fund that invests in hundreds of dividend-oriented companies. With that breadth, a dividend cut at one company is offset by the rest, and the income depends far less on the fate of two or three holdings.

When assessing an individual company, a quality dividend can be identified with five basic checks:

• Payout ratio: a dividend above 80% of net profit signals a possible cut, unless the company has worked this way for years and it is its business model; a sudden rise in the ratio in normal times is the warning sign.
• Consistency: steady dividend growth over the years – so-called dividend aristocrats have raised theirs for at least 25 consecutive years.
• Behaviour in crises: a dividend held or raised in hard years such as 2008 and 2020 is a good sign; a cut is not.
• No debt: borrowing to pay dividends is a damaging practice.
• Cash flow: payments should be covered by free cash flow.

Growth stocks and share buybacks

Growth lets you accumulate rather than distribute: the company reinvests its profit, expands the business, and that shows up in the share price. Mature dividend payers rarely rise 50–60% in a year – nor is that their purpose. The risk with growth is a different one: high expectations. Most companies that promise a great deal fail to deliver, and the exceptions are not the rule. Expectations cannot be measured except through the price, so it pays to ask what the real success rate is.

The dividend’s closest cousin is the share buyback. The company buys back its own shares, fewer shares remain in circulation, earnings per share rise and the price-to-earnings ratio falls – the company becomes more attractive without paying out cash. Shareholders who want to sell can do so, while the rest own a larger stake. Repurchased shares can, however, also be used for acquisitions or to reward managers, which sometimes creates incentives to push the price up artificially.

Growth has its drawbacks too:

• No actual cash reaches your account, so you have to trust the company without the reassurance of a dividend.
• Price swings are considerably larger.
• Growth is often concentrated in a single dominant investment theme – at the time of the episode, artificial intelligence.

Dividends or growth by stage of life

There are no winners or losers here: each approach suits someone, and the choice depends on your goal and time horizon. According to Kliment Robev, all else being equal, the logic by stage runs as follows:

• Young and earning a salary: dividends make little sense; the focus is on accumulation and growth – more aggressive, but without reckless risks or high leverage.
• Seven to eight years before retirement: gradually rather than all at once, at least new money starts to lean towards dividend payers – a shift towards thinking about passive income.
• The final stage: growth loses ground, and passive income brings peace of mind, the ability to use the money and the chance to leave the portfolio as an inheritance rather than selling it off.

Frequently asked questions

This guide is based on season 2, episode 8 of the podcast “Пари и посоки” (Money and Directions): “Dividends or growth? Don’t choose before you understand this”. Summary →

Views reflect his position at the date of publication and are not investment advice. Regulatory information