The world of dividends can be rewarding – but sometimes a little bit confusing too. For example, a zero dividend sounds unattractive, but in some cases I think it could actually be a positive thing for shares I own.
Here is how go about assessing whether a share with a zero dividend could be a good fit for my portfolio.
Growth shares
Often shares are broken into broad groups when people discuss them. One is what are known as growth shares. These are shares in businesses that have the opportunity to grow fast in coming years. That could be a company in a fairly new industry, for example Tesla or NIO in the growing electric vehicle space.
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But growth shares are not limited to new industries. They could also be upstart companies in a well-established industry. For example, I would regard B&M, boohoo and JD Sports as growth shares, although they operate in the centuries-old retail trade.
Depending on their line of business, companies may need substantial capital to grow. For example, they may need to spend on research, product development, expanding facilities and hiring top talent. That can all add up. So a lot of growth shares decide not to pay a dividend and instead use any excess cash they generate to grow their business.
Income shares
At some point, even if a company is still in growth mode, it may decide that it no longer needs to use all its excess capital to fund growth. Think of Apple as an example. Clearly, the company is still in growth mode, trying to increase its market share and sometimes launching new products or services. But a few years back, it also started to pay a dividend. What had been a zero dividend share changed into an income share. The dividend yield, though, is a meagre 0.6%.
Many companies lack the growth opportunities of Tesla or Apple. They may compete in mature industries that generate lots of cash but have limited opportunities for new business development. Classic examples include utilities and tobacco. Their markets tend to be both mature and saturated so there is rarely a need to use huge amounts of capital, although regular capital expenditure for things like maintenance is still common. That can help them pay out large dividends. It is no coincidence that two of the higher-yielding shares in the FTSE 100 are tobacco giants Imperial Brands and British American Tobacco.
Is a zero dividend good?
So, whether a share with a zero dividend makes sense for me depends on my investment objectives.
If I am looking for high dividends, clearly it does not. When I am simply looking for dividends but am willing to accept a low yield because I also want some opportunity for growth, I would consider a zero-dividend share I thought might be about to start paying dividends.
If I was focused purely on growth, I would happily buy a zero-dividend share. The lack of shareholder payouts could mean the company was focusing all its spending on growth. That could help my investment returns just by owning it.
But just because a growth share does not pay dividends says nothing about its potential on its own. I would still want to focus on the underlying investment case for the business.
