Can Twisted Logic Trump Income Investing?

  • March 2, 2006

In a word, yes. If you are wondering what I am rambling about, stay with me a moment. I came across an article on Yahoo Finance yesterday called Growth Strategy Can Trump Income Investing by Juan Carlos Arancibia. I was drawn to this article because most studies have shown that over a long period of time, value investing usually trumps growth investing. Since income investing is a close cousin of value investing, I figured Juan might have some compelling arguments to make.

The article starts out with the following statement “The idea behind income investing sounds logical: Buy bonds and dividend-yielding blue chip stocks, and live off the guaranteed income.” and then goes on to offer reasons as to why growth investing offers better returns when compared to income investing. To make his case, towards the end of the article he lists 20 high yielding dividend stocks and shows how all of them except 2 have performed badly over the last year. There are four major flaws with this reasoning.

  • None of the stocks in the list are blue chips. If the list had included blue chips like AT&T (T), Boeing (BA) and Procter & Gamble (PG), the results would have been completely different.
  • When dividend paying stocks fall, their dividend yield goes up. Stocks with very high dividend yields normally set off red flags, as more often than not, there is something wrong with the company (unless it is a REIT). Serious income investors tend to stay away from such stocks.
  • These 20 stocks represent the bottom of the barrel. This would be similar to comparing Johnson & Johnson (a InsideArbitrage pick) and AT&T (T) to failed biotech and tech stocks, claiming that income investing is better than growth investing.
  • Income investors usually have a longer investing horizon and comparing returns over a one year period may not make sense. Even the worst performing stock on this list, Knightsbridge Tankers (VLCCF) is up slightly over a five year period. With a five year average dividend yield of 16.60%, one could argue that even this stock has outperformed both the Dow Jones Industrial Average and S&P 500 by a wide margin.

While I am a value investor at heart, I have nothing against growth investing and have featured growth stocks in some of my previous investment newsletters. I wanted to play devil’s advocate with this story so that impressionable income investors do not switch strategy mid-stream based on the conclusions of this article. I invite the author to post his comments and carry this discussion further.

Voluntary Disclosure: At this time I do not own positions in any of the stocks mentioned in this blog posting. Nothing in this blog posting should be considered as investment advice or a recommendation to buy or sell securities.