Should You Forget Capital Gains And Just Focus On Dividends?

Are dividends more important than capital gains in the long run?

The Motley Fool

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

While many investors seek capital gains when investing, the reality is that dividends often make up a large proportion of total returns over the long run. Therefore, it could be argued that investors should pay as much attention to their income return as they do to their potential for capital growth. In fact, it could even be argued that focusing only on dividends, and not on capital gains, could be a sound long-term strategy.

Total return

Clearly, the dividend yield on indices across the globe varies significantly. In the US, for example, the S&P 500 currently has a dividend yield of around 2%, while in the UK the FTSE 100 yields 3.8%. Within those indices are a range of dividend yields, with it being relatively straightforward to generate a dividend yield of 4% in both markets, and in stock markets across the globe.

Historically, investors have generated a total return from investing in shares in the high-single digits. Therefore, it could reasonably be argued that dividends could make up at least half of total returns, and possibly more if an investor focused on buying the highest-yielding shares available. Logically, they should therefore spend at least half of their time focusing on the affordability of dividends, a company’s financial strength and the future growth rate of shareholder payouts.

Growth potential

Clearly, companies operating in different industries and in different regions will have dividend growth rates which vary considerably. Some stocks may be able to offer double-digit dividend growth, while others may only be able to keep pace with inflation. In either case, however, a growing dividend can mean that an even higher proportion of total returns are generated from income returns, rather than capital growth, over the long run.

For example, a company which pays a 4% dividend yield today will not only generate an income return on reinvested income, but also potentially offer a rising income return due to dividend growth. Over a long period of time such as a decade, for instance, even a 5% dividend growth rate on a stock which yields 4% can lead to an income return of 6.5% on an investor’s original shareholding. This means that over time there is the potential for an even greater proportion of total returns to be derived from dividends.

Share price catalyst

Of course, dividend yields historically occupy a relatively narrow range. This means that dividend growth usually equates to share price growth, since a company’s dividend yield is kept close to its historic average. If it becomes too high, increased buying by yield-hungry investors would be likely to lower it back to its mean.

Therefore, it could be argued that as well as providing the majority of total returns in the long run, dividends also have a major impact on capital gains, too. This suggests that investors should focus to a much greater extent on dividends than on capital growth in order to maximise their total returns over a sustained period of time.

Just Released! 5 Stocks Under $50 (FREE REPORT)

Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $50 a share.

Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.

Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.

Claim your FREE 5-stock report now!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Investing

Canada day banner background design of flag
Tech Stocks

The Top Canadian Stock to Buy With $5,000 in 2025

There are few Canadian stocks out there that offer the outlook of this tech stock, bound for more growth.

Read more »

A close up color image of a small green plant sprouting out of a pile of Canadian dollar coins "loonies."
Dividend Stocks

I’d Put $15,000 in These 3 Dividend-Growth Champions for Increasing Income Potential

Want to offset some volatility? Here are three defensive dividend-growth champions that can generate a juicy yield right now.

Read more »

Cannabis business and marijuana industry concept as the shadow of a dollar sign on a group of leaves
Stocks for Beginners

Buy the Dip Before It’s Too Late: This Canadian Stock Won’t Stay Cheap Forever

Investors might think that cannabis stocks are out, but this one could be the top Canadian stock to consider.

Read more »

Blocks conceptualizing Canada's Tax Free Savings Account
Dividend Stocks

Transform Your TFSA Into a Cash-Creating Machine With $7,000

Discover how the Tax-Free Savings Account can be your golden goose for generating cash without losing your investment.

Read more »

monthly desk calendar
Dividend Stocks

How I’d Invest $10,000 in Canadian Value Stocks for Monthly Dividend Income

A $10,000-diversified portfolio of value stocks focusing on dividend safety, yield, growth, and payment schedules can provide a reliable source…

Read more »

Canadian dollars are printed
Investing

How I’d Invest $1,000 Right Now for Long-Term Growth

These three Canadian stocks could deliver superior returns in the long run.

Read more »

a person watches a downward arrow crash through the floor
Dividend Stocks

Is This Correction Your Chance? Top 4 Canadian Dividend Stocks on Sale

Stocks may be down, but now is your chance to get some of these top dividend stocks on sale.

Read more »

open vault at bank
Bank Stocks

3 Canadian Bank Stocks to Shield Against Market Downturns

Canadian bank stocks are some of the best options on the market, and these three are probably the top ones.

Read more »