Are you considering investing in stocks? While they may not be for the faint of heart, investing in stocks can help you earn high returns and boost your passive income. Deciding which type of stocks you are investing in makes a big difference here. You have probably already heard of blue-chip stocks and penny stocks. That’s not the only classification for stocks, though. You can also choose between growth stocks and dividend stocks. In this article, we will discuss growth stocks vs. dividend stocks and which make a better investment.
What Are Growth Stocks?
Growth stocks are the shares of any company that you can expect to grow at a rate above the market’s average growth rate. The companies that issue these stocks typically do not offer dividends. You can earn a return by selling these shares in the future and generating high capital gains.
What are Dividend Stocks?
Dividend stocks are issued by companies that make regular dividend payments to investors. Dividends represent a portion of the company’s earnings distributed to its shareholders. Companies usually make these payments at the end of the year, and they may be in the form of cash or additional stocks.
In most cases, blue-chip companies with a proven track record of profitability offer dividend stocks.
Learn more about Motley Fool Millionacres now!Growth Stocks vs. Dividend Stocks: Which Should You Invest In?
To understand which stock options are better for you, let’s compare growth stocks vs. dividend stocks and see the advantages and disadvantages of each.
1. What Do They Offer?
Dividend stocks provide stability and help you generate a consistent cash flow over the years. These stocks are suitable for moderately conservative investors who want to earn money while holding onto the shares of a company.
In comparison, growth stocks offer significantly higher returns than dividend stocks. However, you can only earn a profit when you sell the shares. These stocks are more suitable for high net worth investors who do not need money and can wait for the price of the stocks to appreciate before they sell them.
It’s also important to note that you can also sell dividend stocks in the future if their price increases. In this case, dividend stocks provide capital appreciation, as well as stable cash flow. Growth stocks only offer capital appreciation.
2. How Much Risk Are You Taking On?
Stocks are generally considered to be a volatile asset that poses a certain amount of risk. However, which stocks you invest in can make a big difference here. When it comes to growth stocks vs. dividend stocks, dividend stocks offer less risk than growth stocks. They are less volatile, so if you have a low risk tolerance, you may be better off investing in these shares.
Growth stocks present more risk. There is a fair amount of speculation involved when you invest in these stocks since your returns are based on the possibility that the company will perform at a rate above the rest of the market. If it fails to do so, you could lose your principal investment amount. If you are a risk-taker and are willing to invest in high-risk stocks, then growth stocks may be well-suited for you.
3. How Do They Perform During Bull and Bear Markets?
Another important difference between growth stocks and dividend stocks is how they perform in bull markets and bear markets. Dividend stocks typically perform well during bear markets. Since these stocks belong to well-established companies, you can expect them to perform well during a recession. Even if there is no capital appreciation, you can still receive dividend payments from these companies.
On the other hand, growth stocks perform poorly in a bear market. Since stock prices fall, the value of these stocks also declines, and you won’t be able to earn a profit if you sell these stocks. Your only option here is to wait until the market recovers and stock prices start to rise again.
As far as bull markets go, dividend stocks can perform reasonably well in these market conditions. You will also generate cash flow through dividends. Growth stocks typically outperform in a bull market, and you can earn higher-than-usual returns.
How Can You Identify Growth Stocks and Dividend Stocks?
Now that you understand the difference between growth stocks and dividend stocks let’s take a look at how you can identify them.
1. P/E Ratio
The P/E ratio indicates the price of a share in the market compared to its EPS (earning per share). Growth stocks typically try to maintain a high P/E ratio so that their market price remains high.
Dividend stocks usually have a moderate or low P/E ratio. The stock prices for these shares tend to remain consistent, and you can expect their P/E ratio to reflect that.
2. Sales Growth and Profitability
Companies that offer growth stocks typically focus on maintaining high sales growth and profitability. This is primarily because these factors are linked with the company’s EPS. The more the company earns, the higher its EPS and P/E ratio will be.
You can take a look at a company’s revenues and net profits in the last 3 to 5 years and see if it has witnessed exponential growth in a short period. We also recommend checking how the company plans to sustain this growth in the future.
As far as dividend stocks go, these stocks belong to companies that are stable and reasonably profitable.
3. Dividend Yields
As mentioned earlier, growth stocks do not offer dividend payments. In the case of dividend stocks, though, you can search for companies that offer above-average dividend yields. Choosing a stock with a high dividend yield can help you generate reasonably high cash flow during market slumps and recession.
Wrapping It Up
When it comes to choosing between growth stocks vs. dividend stocks, the final decision depends on your risk tolerance, the kind of returns you are looking for, and your goals as an investor. If you want to take on a moderate amount of risk and generate consistent cash flow, then dividend stocks may be more suitable for you. On the other hand, if you have a high risk appetite and are looking to earn above-average returns, then investing in growth stocks could be the way to go.
We also recommend talking to a financial advisor before you choose to invest in stocks.
Good luck!
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