History shows that dividends have been an important part of total returns for investors in the long run. In fact, various studies have shown that it is the reinvestment of dividends which can deliver the majority of total returns over a sustained period. As such, many investors choose to prioritise dividends when making their investment decisions.
However, the world is currently in the midst of a major bull market. Stock markets across the globe are hitting record highs and the potential for capital growth seems high. Could it therefore be worth focusing on capital growth, rather than on dividend yields?
A bright future
The outlook for the world economy appears to be more positive than it has been since before the financial crisis. In the US, lower taxes and higher spending plans have the potential to rejuvenate the country's GDP growth rate. Certainly, it was already on the path to stronger economic performance before Donald Trump became President. But his tax and spending policies could create conditions which are more conducive to economic growth.
Similarly, in China there has been improved economic performance following fears of a slowdown in recent years. The decision to focus excess capital on infrastructure projects has created higher demand for raw materials, as well as showing that the Chinese growth story still has further distance to run. And in Europe the quantitative easing policy adopted by the ECB is having a significantly positive impact on GDP growth rates across the Eurozone.
With such a positive outlook for the global economy, it is tempting to focus on cyclical companies which could deliver rising profitability. Such companies understandably become more popular during bull markets, and their share price growth can be exceptionally high. As such, many investors may feel that if they are able to generate capital growth in the double digits per year from cyclical stocks, they do not need to worry about obtaining dividends of 4%+. In other words, the high level of capital growth on offer may make dividends of any level far less appealing.
However, the problem with that approach is that investors would no longer be seeking to buy shares when they are low, and sell them when they are high. Certainly, the current Bull Run may last for months or even years. But in many cases, the valuations of cyclical stocks appear to be relatively generous. This could signal that they offer narrow margins of safety, while less popular income stocks could offer good value for money.
In the long run it could be prudent to continue to buy dividend stocks. They may offer scope for capital growth due to lower valuations, while they may also help investors to overcome the potential problems associated with higher spending and lower taxes. While the market is currently focused on its Bull Run, higher inflation may be ahead. In this scenario, dividend stocks could become increasingly in-demand among a range of investors.
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