For many new investors, high dividend yield stocks seem like an obvious choice. The idea of receiving regular income from a stock can feel reassuring and rewarding, especially when the yield is significantly higher than other options. However, focusing solely on dividend yield can sometimes lead investors to overlook the bigger picture—particularly when it comes to long-term growth stocks.
In this case study, we’ll examine how investing in a company like Google (now Alphabet) can be incredibly rewarding over the long term, even though its dividend yield is relatively modest. By focusing too much on high-yield stocks, investors might be missing out on the substantial benefits of capital appreciation that growth stocks can provide.
The Investment: A Case Study in Google (Alphabet)
Let’s take a hypothetical investor who purchased Google stock many years ago. This investor spent $10,600 USD on shares of Google at the time. Fast forward to today, and the stock has appreciated significantly, with the shares now worth approximately $62,500 USD.
Additionally, Google began paying a quarterly dividend in recent years, and the investor now receives $75 USD per quarter, or $300 USD annually.
Key figures in this case study:
- Initial investment: $10,600 USD
- Current value: $62,500 USD
- Quarterly dividend: $75 USD
- Annual dividend: $300 USD
- Dividend yield on original investment (cost basis): 2.83%
- Dividend yield on current value: 0.48%
While the dividend yield on the current value of the stock seems low, the overall return, when considering both capital appreciation and dividends, tells a much fuller story.
Dividend Yield: What It Means and Why It Can Be Misleading
A company’s dividend yield is calculated as the annual dividend payment divided by the current stock price. For example, if a stock is priced at $100 and pays an annual dividend of $5, the dividend yield is 5%. While high dividend yields may seem appealing, they aren’t always the best indicator of a successful long-term investment.
Investors seeking income are often attracted to stocks that offer high dividend yields, sometimes upwards of 5% or 6%. But high yield doesn’t always equal high quality. In many cases, companies with high yields may be compensating for slow growth or even declining business performance. For instance, mature industries such as utilities or telecommunications tend to offer higher dividend yields but have limited opportunities for growth.
On the other hand, companies that focus more on growth than dividends—like Google—may offer lower yields initially but provide greater potential for capital appreciation. This is where long-term investors can benefit.
The Power of Capital Appreciation
In the case of our hypothetical investor, the initial investment of $10,600 USD in Google has now grown to $62,500 USD, representing a 489% increase. While the dividend yield today is only 0.48%, the increase in the stock’s value far outweighs the modest dividend payout.
This is a great example of how capital appreciation can create wealth far beyond what a high dividend yield might offer. Google, as a company, chose to reinvest its profits into expanding its business rather than paying substantial dividends in its earlier years. By doing so, it was able to grow into a dominant player in multiple industries, leading to a significant increase in stock price.
For long-term investors, capital appreciation—the increase in the stock’s price—is often the most important factor in determining the overall success of an investment. While dividends provide immediate income, capital appreciation offers the potential for much larger gains over time.
Dividend Yield on Cost: A Different Way to Measure Success
One important concept that many investors overlook is dividend yield on cost. This is the dividend yield based on the original price paid for the stock, not its current market value. In our case study, the dividend yield on cost is 2.83%, meaning the investor is earning a healthy return on their initial investment even though the current yield is much lower.
This is a crucial factor for long-term investors to understand. As companies mature, they may increase their dividend payouts. If Google continues to raise its dividend over time, the yield on the original investment (the cost basis) will increase. This means the investor will continue to see a growing income stream from the dividends, in addition to the appreciation in the stock’s value.
By focusing on quality growth companies with the potential for both stock price increases and dividend growth, investors can build substantial wealth over time—something that might not happen with high-yield stocks that offer limited growth potential.
Why Investors Focusing on High Dividend Yield Stocks Might Miss Out
While high dividend yields are appealing for those looking for immediate income, there are several risks and missed opportunities associated with focusing solely on these stocks.
1. Missing Out on High-Growth Opportunities
Growth companies like Google often don’t pay high dividends because they are reinvesting their profits to expand the business. Although this may mean smaller dividend payouts in the early years, the potential for long-term growth is much greater.
For example, in the case study, Google’s stock appreciated by 489%, which far exceeds the returns typically offered by high-dividend-yield stocks in more mature industries. Investors who focus solely on yield may miss out on these high-growth opportunities that could significantly increase their wealth over time.
2. Short-Term Income vs. Long-Term Wealth Creation
Focusing on high dividend yields can sometimes lead investors to prioritize immediate income over long-term gains. While dividend payments are a form of income, they can come at the expense of future growth. High-dividend-yielding companies often belong to industries with limited growth potential, which can cap the stock’s price appreciation.
In contrast, growth stocks like Google have the potential to increase in value significantly over time. Although they may offer smaller dividend payments initially, the long-term wealth creation from capital appreciation can be far more rewarding.
3. Dividend Cuts and Sustainability
One of the risks of high dividend yield stocks is the potential for dividend cuts. When a company is paying out an unusually high percentage of its profits in dividends, it may be unsustainable over the long term. If the company faces financial difficulties or an economic downturn, it may be forced to cut or even eliminate its dividend, leading to a reduction in income for investors.
Growth companies like Google, which offer smaller but sustainable dividends, are often in a better position to maintain and grow their payouts over time. These companies typically have stronger balance sheets and more flexibility to reinvest in their business, making them more resilient during tough economic periods.
Total Return: Focusing on the Big Picture
When evaluating an investment, it’s important to look at the total return, which includes both capital appreciation and dividends. In our case study, while the dividend yield on Google is modest, the stock’s dramatic price increase has generated significant wealth for the investor. This total return far exceeds what could have been achieved by focusing solely on high-dividend-paying stocks.
By combining capital appreciation with a growing dividend, growth stocks like Google can provide the best of both worlds. As the company continues to mature, it may increase its dividend payouts, offering both income and the potential for future growth.
Lessons for New Investors: Why You Shouldn’t Just Chase Yield
For new investors, it’s tempting to chase high dividend yields. However, this approach can limit the overall potential of your portfolio. By focusing solely on yield, you may miss out on high-growth stocks that have the potential to increase significantly in value over time.
Here are some key takeaways:
- Capital appreciation can create significant wealth over the long term. While dividends provide income, growth stocks offer the potential for substantial gains through increases in stock price.
- Dividend yield on cost is an important metric to consider. Even if a stock’s current yield is low, the yield based on your original investment may increase over time as the company raises its dividend.
- High yields aren’t always sustainable. Companies paying very high dividends may be at risk of cutting their payouts if they encounter financial difficulties.
- Balance is key: A portfolio of quality growth stocks with the potential for both price appreciation and growing dividends can be a more effective long-term strategy than focusing on high yield alone.
Conclusion: Look Beyond the Dividend Yield
While high dividend yields may seem attractive, they aren’t the only factor to consider when making long-term investment decisions. Growth stocks like Google, with their potential for significant capital appreciation and eventual dividend growth, can offer far greater rewards over time. By balancing your portfolio between growth and income, and focusing on total return, you can build wealth steadily and sustainably.
Happy investing!