Dividend Investing vs. Buy Low, Sell High

Without dividends, stocks are worthless. This may seem like a bold statement at first, but as you consider the importance of dividends, you will understand why this statement is so true. Consider this question: when you purchase a stock, how do you expect to increase your wealth? There are really only two ways you can answer this question. First, you can say that you intend to sale the stock for more than you paid. Or, second, as an owner/shareholder, you can claim your portion of company earnings. That’s it.

So, which approach should you subscribe to? Let’s take a deeper look at the first approach: buy low and sell high. The real question here is this: why do stock prices rise and fall? Ultimately, stock prices rise and fall according to investors beliefs about the firm’s ability to earn a profit now and in the future. Investors care about earnings because as a shareholder, you have claim on current and future earnings—through dividend disbursements. Simply put, stock prices are based upon investor’s beliefs about future earnings.

The “buy low” approach is based upon your ability, or your broker’s ability, to identify stocks that the market is incorrectly valuing. This approach is very risky and may require much more time and energy. However, if successful, you can realize significant short-term gains. There are many ways in which brokers, money managers, or everyday people claim to “beat the market.” If they have figured out the secret, they probably won’t tell you.

Dividend investing, on the other hand, is about investing in a firm for the sole purpose of capturing earnings. This strategy is arguably less risky and will require less day-to-day analysis because it focuses on the long-term. While there is a “buy low, sell high” component to dividend investing (because you won’t hold a stock forever), the main emphasis is on long-term performance. The advantage to this approach is that dividend investors don’t have to bet on the market being wrong. Dividend investors just have to be right about the company’s ability to perform.

There are several ways in which you can determine how a company will perform. The most widely used approach to assessing performance by looking at the company’s history. More specifically, pouring through financial statements like cash flows, balance sheet, income, and dividend disbursements and policies. Another approach is to look forward by assessing factors such as the industry outlook, brand strength, management competence, or potential growth opportunities. Or, a much easier approach: take an analysts word for it.

In the end, the best investment approach depends on your appetite for risk and your ability to “beat the market.” Whether you like arbitrage, or income investing, you should make sure to diversify your risk across different industries and securities.