Dividend or no Dividend, which is better?

Dividends are simply cash that a listed (or unlisted) company pays out to its investors. These monies come out of a companies earnings, or at least should come out of their earnings. Occasionally you will get a company selling assets to pay out its dividend. They do this to entice unwitting investors, and the insiders will sell chunks of stock when the share price has become inflated. As is the case with Ponzi schemes aka. Bernie Madoff, you will see a company paying out dividends to its old investors out of money it has received from new investors. In both of these cases you should stay well away. Often you will find that a dividend over 5% is a warning sign that either the dividend is unsustainable or the company is in financial difficulty. Remember that the dividend you will typically see stated is a trailing dividend, and so reflects the prior years dividend payout per share, as compared to the current share price. If the share price has fallen a great deal, the prior years payout will look really good, which obviously will not be sustainable.

Any net earnings not paid out by a company as a dividend are called retained earnings. It is essential that a company retains some of its earnings to continue growing its' business. So a general rule is to stay away from companies that have a 100% payout ratio. The possible exceptions to this are oil pipeline operators and REITs (Real Estate Investment Trusts). The reason for this is that the structure of their financials are different to other listed companies. They are also very capital intensive businesses, and the maintenance expenses of these assets come out of their gross income, not net earnings. The flipside to possibly receiving a juicy 10% yield out of a capital intensive REIT, is that their growth will be limited. So the black and white question here is whether you opt for a sustainable dividend, or a company with higher revenue growth and no dividend?

Often profitable tech stocks like an Alphabet or Xero or Salesforce will not pay a dividend for the simple reason that they can grow their businesses faster by retaining 100% of their earnings. Paying a dividend to their investors would severely limit their ability to grow, and negatively impact the possible share price appreciation that the investor could see. There is of course a lot of unprofitable companies out there, and the stocks of these companies will not pay a dividend either. It is possible that you could see tremendous share price growth in these types of stocks, but it is more likely that on average, that you will lose money. But had you thrown a dart at a board and landed on Alphabet or Xero in its early stages, you would be soundly beating an investor in a high-yielding REIT.

So in summary, it is not wise for an investor to buy into a company that is paying its dividend out of capital. Nor is it wise to invest in a Ponzi scheme. You should watch that a stocks dividend is sustainable going forward. Investing a well-run high-yielder is not a bad idea; particularly if you are aiming for income over growth. But investing in a well-run growth stock is not a bad idea either, because if you choose the right ones, the share price growth can be astronomical aka. Xero. Ultimately though, it comes down to what you are looking for, if you would like some extra income, or are okay to forgo some income today for a bigger capital gain in the future. And luckily on Hatch or Sharesies, you can do both!