Make no mistake, I think dividend income is one of the best things you can get from an ASX share. It's truly passive income — it doesn't discriminate on who you are, where you are or what you do. If you own a dividend-paying share, you shall receive it.
Now, some ASX investors only invest for dividend income. If a share pays no dividend, these investors just won't be that into it.
On one level, I understand this perspective. Some dividend investors, such as retirees, for example, rely on shares to fund their living expenses. Capital appreciation isn't as useful as a regular stream of cash flow. Even for those investors who don't need dividends to fund their lifestyles, I understand the appeal of having cash regularly coming through the door. It can supplement your other sources of income, help give you extra capital to invest or otherwise just give you that tangible reassurance that your money is making you more money.
But I also believe that a complete focus on dividend income can be a mistake for many investors. Here's why:
The downside of a dividend share
To understand the downside of a dividend, we first have to understand where dividends come from. When a company makes a profit, it has three things it can do with the money: reinvest it back into the business, keep it on its balance sheet or return it to shareholders via share buybacks or dividends. Thus, like everything in life, the payment of a dividend comes at an opportunity cost. If a company chooses to pay a dividend, it is concurrently choosing not to invest that money back into the business. That's why some companies don't pay dividends at all – they prefer to maximise growth for the company.
Now, some companies are large and mature, with no real growth opportunities in front of them. Take Woolworths Group Ltd (ASX: WOW). There are very few Australian towns or cities left that don't have a Woolworths within driving distance. It's simply not viable for Woolies to keep building extra stores on every street corner because the Australian grocery market is pretty much at saturation point. Rather than ploughing every cent of its profits into adding 200 new Woolies stores every year, the company is instead choosing to pay out a reasonable dividend. That's an action I'm sure the shareholders of Woolworths think is appropriate, given the absence of any massive growth opportunities in front of the company.
Should you go for growth instead?
So, if you're only choosing to invest in companies like Woolworths that offer substantial dividend income upfront, you will likely have a portfolio full of mature businesses operating in fairly saturated markets. That's not a recipe for a market-beating ASX portfolio. You are excluding a lot of companies that are investing in growing their own future at the expense of companies that simply can't grow too much larger. Remember, a company will usually only pay a substantial dividend if it has nothing better to do with the money. So if you rely on this income to fund your lifestyle, you might be ok with that. But if you're looking to use ASX shares to build wealth as fast as possible, I think dividends should be a secondary consideration.
