Buying dividend stocks rather than growth stocks may sound like a strange idea to many investors. After all, dividend shares have historically been viewed as the preserve of income investors, rather than individuals who are seeking to generate growth within a portfolio.
However, with many growth stocks now trading on high valuations after the recent stock market rally, I think dividend shares may offer better value for money. They could also gain in popularity as a result of a lack of income investing opportunities available elsewhere. The result could be high total returns in the coming years.
Value opportunities among dividend stocks
While the stock market rally has lifted the valuations of many shares, it is still possible to obtain relatively high levels of passive income from dividend stocks. In fact, around a fifth of the FTSE 100’s members offer yields in excess of 4% at the present time. This suggests that there may be a number of large-cap companies that offer good value for money. Although this does not guarantee share price growth in future, it can suggest that there is greater scope for capital appreciation.
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By contrast, many companies that have impressive earnings growth forecasts have risen sharply in value in the recent stock market recovery. Investors seem to have become increasingly focused on those businesses that are expected to produce rapid rises in their bottom lines. The result of this, in some cases, is a high valuation. This may limit the potential of growth stocks to deliver further share price gains, since investors may already be ‘pricing in’ their prospects.
Increasing appeal of dividend shares
Dividend stocks may become increasingly attractive over the coming years. Although predicting interest rates is notoriously challenging, it seems relatively likely that the days of 4%-5% interest rates are not set to return for a prolonged period of time. This may mean that some passive income investors switch from other income-producing assets, such as cash and bonds, to dividend shares due to their relatively high income return prospects.
This high demand for dividend shares may mean that they offer greater return prospects than the wider stock market. Even if they match the wider stock market’s rise, they could offer the prospect of producing a high single-digit total return on an annualised basis, as per the past returns of indexes such as the FTSE 100 and FTSE 250 over recent decades.
Clearly, there is no guarantee of any future returns from any stock. The stock market may fail to match its previous capital growth rates, while dividend stocks may also struggle to deliver high total returns. However, their low valuations and potential to become more popular could mean that they offer a greater chance of producing market-beating returns in the long run.
