Should I invest in dividend stocks or growth stocks?

Podcast Duration: 05:42

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Welcome to Angel Broking’s podcast.

There are multiple stock market investment strategies. You too must have heard a number of strategies. Some people say that find your target buy-sell prices and trade accordingly. Some say valuations don’t matter much if the company has growth potential. You can buy at any price if the company has growth potential.

Betting on the growth of a company is a relatively safe strategy in India as it is a developing country with several sectors and companies growing at a rapid pace. It takes just a few years for a small company to scale up, with drastic growth in profits and sales.

Stock prices generally mirror the growth of a company. But are strategies formulated in normal times effective during exceptional times like these? Or do we need to re-strategise?

The Covid-19 pandemic is a once-in-a-lifetime event. The overall impact of the crisis is not clear, but it can be said with certainty that the stock markets will be volatile in the near future. Both the benchmark indices—Sensex and Nifty—fell 23% each in March. However, BSE Sensex rebounded 11% in April while the NSE Nifty rose over 14% in the month.

When volatility and uncertainty are high, stability should be given preference over growth. Dividend-paying stocks can help you bring some stability to your portfolio. However, investing only in dividend stocks may not be the ideal solution.

You will have to skillfully balance between growth stocks and dividend stocks. Let us discuss in detail questions like how to invest in dividend stocks, how to choose growth stocks and what proportion to maintain.

Any discussion on dividend stocks would be incomplete without mentioning dividend yield. It is an important metric to analyse dividend stocks

The dividend yield is a financial ratio which is derived by dividing the amount of dividend paid out in a year by the current market price. Let us understand the importance of dividend yield.

Dividend-paying stocks help you grow the invested money in two ways - dividend returns and capital appreciation due to an increase in the share price. Since you are investing in a dividend stock, it is important to know the dividend-only return. The dividend yield gives an idea of the dividend-only returns of a stock.

After the stock market meltdown due to Covid-19 crisis, many stocks are trading at attractive dividend yields. But just looking at dividend yield may backfire as dividend yield automatically increases when the stock price declines.

Pick dividend-paying large-cap stocks. Large-cap stocks are likely to recover faster from the crisis. The speed of recovery is important as no one invests just to receive dividends. Moreover, a dividend is paid from the profits of the company. If profits decline substantially, the company may be forced to reduce dividends.

Another major factor in favour of large-cap stocks is that dividend payout can affect the growth prospects of mid-cap stocks.

Tough market conditions coupled with the reduction in money available for growth can severely affect the growth potential of a company, which is why you should stick to large-cap stocks during the current crisis. Dividend stocks will generate a steady income for you, similar to fixed return instruments like fixed deposits. Dividend stocks seem a good investment considering the instability and volatility in the market. But entering the equity markets with a short term investment horizon is not advisable.

If you are a long-term investor, you should also take the company’s growth trajectory into account. Most companies overtly focussed on paying dividends are not very efficient growth generators.

If you limit your portfolio to dividend stocks, you may miss the chance to multiply wealth during the growth phase expected to follow the crisis. It is pertinent to invest in dividend-paying companies that have good growth potential.

Additionally, invest a part of the total funds in growth stocks. There is no surety of growth in the short-term, but they are likely to generate good returns in the long run.

A diversified portfolio will ensure that you have a steady income through dividend stocks and will also be able to capitalise on the growth of companies.

Now a question arises, how do you balance dividend stocks and growth stocks? It a fairly easy task!

While choosing dividend stocks, focus on valuations, earnings growth expectations and upside potential, besides the dividend yield.

It is pertinent to note that dividend is generally paid by state-owned companies, but they may not be the best option for capitalising on growth. Don’t forget to add private companies to the mix as they provide good growth potential.

Let us discuss the investing strategy for growth stocks in brief. Just like dividend stocks, give preference to large-cap stocks while investing in growth stocks. Specific sectors like pharma, telecom, FMCG can be considered for investment.

However, certain parameters should be kept in mind. Opt for companies with strong cash flows, low debt, stable business and clear growth potential. You can add some mid-cap with strong growth prospects. In the case of mid-cap stocks also, opt for financially strong companies with a business moat as many companies may not survive the current crisis.

With the focus on stability and capital protection, it is advisable to have more dividend stocks in your portfolio. The aim should be to create a dynamic portfolio, with a focus on dividend stocks. You can divide dividend and growth stocks in 60:40 ratio. The proportion can be modified as per the preference and investing style of individual investors.

The most important point to remember in these times is that the bulk of dividend stocks in your portfolio should have strong growth potential!