Should you buy passive income or bet on growth stocks?
This is one of the fundamental dilemmas that investors face.
On the one hand, passive income tends to be more reliable, coming in whether the market is up, down or sideways. On the other hand, growth stocks often deliver superior total returns. As an individual investor, it’s often hard to know which is best for you.
The case for buying passive income
The case for buying passive income instead of growth stocks revolves around the fact that dividend income tends to be very reliable. If a company is of high quality, it tends to pay consistent dividends in up, down, or sideways markets. It doesn’t matter what the market is doing on any given day: as long as the earnings are strong, the dividends keep coming in.
Consider Brookfield Asset Management (TSX:BAM). The first half of 2023 was a tough time for financial services companies like Brookfield. In the spring of 2023, several U.S. banks failed, when a rush to withdraw money caused their cash holdings to decline in value. The panic in the banking sector eventually hit even non-bank financials like BAM, which declined 4% in the month of March.
If you’d been counting on capital gains to carry you through that period, you might have had to sell stock at low prices. Although BAM, on a fundamental level, was not affected by the banking crisis, its stock was. However, since BAM as a company was doing fine, it kept paying its dividend throughout the crisis. That dividend offers investors a 3.75% yield at today’s prices. So, BAM has been a very reliable dividend stock over the years.
The case for betting on growth stocks
Having explored a case for investing in dividend stocks, it’s time to look at an alternate case for investing in growth stocks.
Growth stocks tend to be great performers over time in terms of total returns. Because they are not paying out dividends, growth companies have more money to re-invest in their business, leading to large increases in revenue and earnings. Over time, this can lead to superior stock price appreciation.
Consider Shopify (TSX:SHOP). This is a stock that has increased 2,350% in price since it went public. The reason for the company’s superior performance in the market is the fact that it reinvests heavily in its business.
Shopify does not pay a dividend, so it is free to invest cash in its business to generate future growth. The result of this is a high revenue growth rate. In the most recent quarter, SHOP’s revenue grew at 25%. In the overall period since the company went public, revenue has grown at 45% annualized on average. Because it doesn’t pay dividends, SHOP has delivered a great total return for those who got in early. This is the main advantage of growth stocks in general: continual re-investment.