Should I Buy Dividend Stocks or Growth Stocks?

You don't have to read investing blogs very long before coming across the idea of investing in dividend growth stocks--stocks that pay a yearly dividend and which have historically increased that dividend on a regular basis.

Those who champion dividend growth investing liken it to planting a money tree--once you have planted it (purchased the stocks), the fruit is there for the picking (dividends are paid regularly) and increases as time goes on.  The stock that pays you a $3.00 dividend this year may pay you $3.10 next year (or it may pay less if business is not good).

Last week I read an blog post (and I wish I had bookmarked it) in which the author eschewed dividend growth investing, stating that generally when dividends were declared, the value of the shares dropped the same amount, giving you a zero-sum game, except that you had to pay taxes on the dividends.  Something about that statement didn't sound right to me, so I did some math.

Disclaimer:  The last time I took a standardized test, my verbal skills were in the 99th percentile, and my math skills, dead average.  Make of it what you will.  

Trying to figure out what WILL happen in the stock market is, at best, an educated guess and it isn't very useful for comparison purposes.

The shares of a particular company pay increase or decrease in price due to factors unique to that company.  In other words, if a company has a great new invention that "everyone" wants to buy, investors may bid up the price of the stock in that company.  In the same way, if something happens so that the company's future prospects look bad, investors may seek to sell off the stock and the and the price per share will drop,

On the other hand, sometimes the price of stocks will change, sometimes substantially, not because of anything good or bad that happened to the company but because the market as a whole has moved and they get caught up in it.

In other words, while the price of a company's stock is, to some extent, a reflection of the current and expected profits of the company, there are times that prices of shares of stock in a particular company may drop for reasons that have little to nothing to do with the company.

Dividends, on the other hand, are a reflection of earnings.  If a company isn't making a profit, the only way it can pay a dividend is to use savings, and no company can do that long-term.

So, back to the question, is it better to own stock in a company that pays a dividend, or a company that does not, assuming the same rate of growth?

I did the following math:

Since I know the average stock market return over the long haul is about 7%, I used random.org to randomize numbers between -10 and 20 to come up with a string of numbers that my eyeball estimate told me averaged close to that.  Actually I ended up with numbers that average a little over 5% and decided to stick with them.

I used those numbers as the percent increase in the stock price in a given year.  I started with 500 shares of stock that cost $100 each.  Each year I assumed the growth rate was my random number and figured out how much I would have at the end of the year.  Here is the chart I got:

Year	Return	no of shares	open price/share	end price per share	total value end
1	-0.02	500	100	98	49000
2	0.13	490	98	110.74	55370
3	0.01	565	110.74	111.8474	55923.7
4	0.16	505	111.8474	129.74	64870
5	0.08	579.9866604	129.74	140.1192	70059.6
6	-0.09	540	140.1192	127.508	63754.24
7	0.05	455.0000285	127.508	133.883	66941.7
8	0.11	525	133.883	148.61	74305.06

I never took any money out of this account and at the end of eight years I had $74,305.06.  But what if this had been a dividend paying stock?  Would it make any difference?  My guess before I did the math, was that it wouldn't make a diffence in the accumulation  phase.  I was almost right.

I used the same return rates on the second chart.  The difference is that I assumed that this stock paid a $3,00 per share dividend on the last day of the year, and that the stock then fell in price by 3.00. In other words, if the stock sold for $98 on the last day of the year, I opened it the next year at $95 rather than $98.  However, I used that $3.00 per share to buy more stock at that opening price.  At the end of the year, I computed the value by multiplying the number of shares from the beginning of the year by the post-dividend price, and then adding the dividends paid.  

Year	Return	# of shares	open price/share	pre-dividend close	$3 dividend	post div close	total end value
1	-0.02	500	100	98	1500	95	49000
2	0.13	515.7894737	95	107.35	1547.368421	104.35	55370
3	0.01	530.6181121	104.35	105.3935	1591.854336	102.3935	55923.7
4	0.16	546.1645515	102.3935	118.77646	1638.493654	115.77646	64871.492
5	0.08	560.3167691	115.77646	125.0385768	1680.950307	122.0385768	70061.21136
6	-0.09	574.0906949	122.0385768	111.0551049	1722.272085	108.0551049	63755.70234
7	0.05	590.0295262	108.0551049	113.4578601	1770.088579	110.4578601	66943.48745
8	0.11	606.0545386	110.4578601	122.6082247	1818.163616	119.6082247	74307.27107

What About During Withdrawals?

I redid the first chart, only this time, after computing the value on the last day of the year, I withdrew $5,000, which reduced the number of shares with which I started the next year.  Here are my results:

Year	Return	no of shares	open price/share	end price per share	pre-withdrawal value	post withdrawal value
1	-0.02	500	100	98	49000	44000
2	0.13	448.9795918	98	110.74	49720	44720
3	0.01	403.8287882	110.74	111.8474	45167.2	40167.2
4	0.16	359.1250221	111.8474	129.742984	46593.952	41593.952
5	0.08	320.5872928	129.742984	140.1224227	44921.46816	39921.46816
6	-0.09	284.9042101	140.1224227	127.5114047	36328.53603	31328.53603
7	0.05	245.6920313	127.5114047	133.8869749	32894.96283	27894.96283
8	0.11	208.3470991	133.8869749	148.6145421	30963.40874	25963.40874

I then re-did the chart, assuming that after the dividend had been paid, I used it as part of the $5,000 I withdrew.  I thought the dividend payer would come out ahead.

Year	Return	# of Shares	Price per share	pre-dividend close	$3 dividend	post div close	pre-withdrawal	post withdrawal
1	-0.02	500	100	98	1500	95	47500	44,000
2	0.13	463.1578947	95	107.35	1389.473684	104.35	48330.52632	44,720
3	0.01	428.5577384	104.35	105.3935	1285.673215	102.3935	43881.52678	40,167
4	0.16	392.2827133	102.3935	118.77646	1176.84814	115.77646	45417.10386	41,594
5	0.08	359.2608722	115.77646	125.0385768	1077.782617	122.0385768	43843.68554	39,921
6	-0.09	327.1217119	122.0385768	111.0551049	981.3651357	108.0551049	35347.17089	31,329
7	0.05	289.9311056	108.0551049	113.4578601	869.7933168	110.4578601	32025.16951	27,895
8	0.11	252.53941	110.4578601	122.6082247	757.61823	119.6082247	30205.79051	25,963

Well, you can tell I write these posts on the fly because obviously, there is no difference (or at least no significant difference) between getting dividends and having the price of the stock increase, whether you are trying to accumulate more stock or whether you are trying to generate cash to spend.

That conclusion, of course, assumes that there is no difference in the stocks, which is something that rarely happens.  In general, companies that are profitable and growing at a slow but steady pace, if at all, pay dividends.  Companies that are re-investing everything they have into growing the companies do not pay dividends, but hopefully the price of the stock will increase in the long run.  Of course if they overbuild, then the stock can crash for that reason.

Are you a dividend investor?  If so, has my little exercise made you reconsider your stance?  Why or why not?