Today we will take a look at the difference between dividend and growth stocks. What do these two things mean? For most long investors it is mainly a difference in expected returns over several years.
The bottom line for traders is that since investors receive some returns as cash directly from the company, price movement follows different patterns than a growth stock.
Let's quickly go through the rationale for issuing dividends. A company competes for investor cash against similar companies, with the company having the highest returns tending to attract more capital. Makes sense right?
When companies are private (like Koch Industries for example), this is a very significant market force, because in general, investor cash goes directly into the company for use by the company to use as they see fit.
In the public markets shares are traded between investors, cash is exchanged between investors, and the company's capitalization does not change when these trades occur.
This is because earnings directly correlate to the amount of near-term dividends. For very large firms that have been paying dividends for many years this is not true.
The firms tend to have large cash holdings and want to pay the same dividend every quarter regardless of earnings. So a dividend stock is likely to experience price changes over the period of time between earnings guidance and earnings reporting.
If earnings are lower than expected, the price should fall, and if higher than expected, the price may rise. During the time leading up to earnings reporting, news about the firm can cause earnings expectations to rise or fall, leading to a price change.
The reason being that the company has reduced its cash holdings and literally become less valuable. Any investor who buys a share the day before a dividend is announced will receive the dividend, and an investor who buys a share one day later will not.
This is why you may see prices rise into a dividend date on a stock chart. It is reasonable to expect to pay a different price in these two situations.
This means that factors unrelated to the company's success or value are in play. If positive news (like a cure for cancer) about a competing sector come out one morning, a lot of investor cash will move into that sector, possibly temporarily lowering prices for other sectors.
If that is the day you choose to trade to take profits, you may have to take a lower price for your shares than you might have on a different day. Knowing support and resistance levels can help with this situation greatly.
Another major difference between the two types of stock is in the tolerance of the market to volatility. If a dividend stock cuts its dividend for the first time in a long time, investors will react negatively.
If a growth stock misses targeted earnings, in many cases, the market barely notices. If a dividend stock starts trading in a wider range than expected, investors may be concerned and the company may need to provide additional guidance.
If a growth stock starts trading in a different pattern or range, long term investors will tend to shrug it off and the company generally will make no attempt to explain or influence the price.
Thus, volatility in price can be expected to happen for longer periods for growth stocks than for dividend stocks.
This also means that a growth stock can recover quickly from a significant drop in price, while a dividend stock may face more resistance in recovering from a loss.
If you are following technical analysis, you might consider focusing on the price action playing out on the chart.
We hope you enjoyed this post on dividend versus growth stocks. The Bullish Bears enjoys teaching our readers about different concepts in the stock market.
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