In choosing dividend investing vs value investing, it’s important to recognize that both can lead to favourable returns
To decide between dividend investing vs value investing, investors must first distinguish between the two. The best dividend stocks respond to tough economic times by doing their best to maintain, or even increase their payouts.
Value stock picks can test your patience by moving sluggishly for months, if not years. But the best value stocks can make up for it by rising sharply when investors discover their true value.
But whether you choose dividend investing vs value investing, note that both can lead to favourable returns if you pick the right stocks. That helps explain the lasting appeal of value stock picks.
Dividend investing vs value investing: Dividend-paying investments can be among your best holdings
We’ve always placed a high value on a record of dividends, mainly because it provides something of a pedigree for stocks we recommend. After all, you can’t fake a record of dividends. It takes a lot of success and high-quality management for a company to have the cash and the determination to declare and pay a dividend every year for five or 10 years. It’s not something you can create at the spur of the moment.
If you stick with top-quality high dividend paying stocks, the income you earn can supply a significant percentage of your total return—as much as a third of your gains. And at the same time, dividends--including those from value stock picks--are more dependable than capital gains as a source of investment income.
At TSI Network we think Canadian dividend stocks are some of the best investments you can own. Value investing in Canada can be particularly fruitful when focusing on dividend-paying stocks.
Dividend investing vs value investing: The Canadian dividend tax credit offers more
Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.
This means that dividend income will be taxed at a lower rate than the same amount of interest income. Value investing in Canada becomes even more attractive when factoring in the favorable tax treatment of dividends.
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Dividend investing vs value investing: Value stocks come with lower prices than other stocks
On the question of dividend investing vs value investing, one of the best ways to boost your portfolio returns is to buy high-quality “value stock picks” (or stocks that are reasonably priced, if not cheap, in relation to their sales, earnings or assets), then hold on to them as investors recognize their value and push up their share prices. Value investing in Canada allows you to identify undervalued stocks poised for growth.
Value stock picks are typically stocks trading lower than their financial fundamentals suggest. They are perceived as undervalued, and have the potential to rise. Note that many new tech stocks, for instance, start out as growth stocks and transition into value stocks.
They have low price-to-earnings and price-to-book ratios—making them less expensive than other stocks. And at the same time, they may also pay dividends. Due to these fundamental distinctions, a value stock is often traded at a more affordable rate than other stocks.
Dividend investing vs value investing: Value investing can lead to “value traps”
You need an eye for value stock picks to succeed as an investor. But focusing on value measures alone can steer you into unsuccessful investments that are sometimes referred to as “value traps.”
Some of the measures that lead you into value traps are statistical. They include unusually high dividend yields, unusually low per-share price-to-earnings, or P/E, ratios, or a low ratio of stock price to book value or other measures of per-share value.
Any of these measures can make it seem like a stock is a bargain. But in fact, any of them can simply be due to a low stock price that is the result of selling by well-informed investors who recognize a dismal long-term future.
Another way to fall into a value trap when considering value stock picks is to put too much faith in the value of a brand name. A strong brand can sell a lot of strong product, or keep an over-the-hill product going long after competitors have faded. But even the strongest brand name can only do so much.
Final note on value investments: No investment can ever be so attractively undervalued or desirable that it overcomes a lack of integrity on the part of company insiders.
There’s no limit to the number of ways that unscrupulous insiders can cheat their investors. Key point: If you have any doubts about the integrity of insiders, sell immediately.
In summary, when it comes to dividend investing vs value investing in Canada, both strategies can lead to favorable returns for investors. Dividend investing focuses on companies that consistently pay out a portion of their earnings to shareholders, providing a reliable income stream. Value investing, on the other hand, involves identifying undervalued stocks with strong fundamentals and growth potential.
Canadian dividend stocks offer the added benefit of the dividend tax credit, which reduces the effective tax rate on dividend income compared to interest income. Value investing in Canada allows investors to uncover hidden gems trading at discounted prices relative to their intrinsic value.
However, value investing comes with the risk of falling into “value traps” - stocks that appear cheap based on metrics like high dividend yields or low price-to-earnings ratios, but are actually in decline. It’s important for investors to thoroughly research companies and their management before making investment decisions.
Ultimately, both dividend investing and value investing can be profitable strategies for Canadian investors. By carefully selecting high-quality companies with strong fundamentals and attractive valuations, investors can build diversified portfolios that generate both income and capital appreciation over the long term.
What’s a stock you’ve invested in that genuinely qualifies as a value stock pick?
This article was originally published in 2018 and is regularly updated.
