Why I'd buy and hold cheap dividend stocks for more than just a passive income

Cheap dividend stocks could deliver high capital growth due to their low prices and lack of passive income potential from other mainstream assets.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Many investors may view today's cheap dividend stocks solely from a passive income perspective. In other words, their high yields provide a generous income return and little else.

However, undervalued income stocks could deliver impressive capital returns alongside a passive income. Their low prices may equate to capital growth potential – especially as low income returns available on other mainstream assets push investors towards dividend shares.

Capital growth opportunities from cheap dividend stocks

Despite the 2020 stock market rally, there are a wide range of cheap dividend stocks available to purchase today. In many cases, they face challenging operating conditions in the short run that have caused investors to demand a wide margin of safety.

While this may limit their scope to deliver capital growth in the short term, over the long run they could benefit from improving operating conditions as part of a global economic recovery.

Therefore, buying them now while they trade at a discount to their intrinsic values could be a shrewd move. It may enable a long-term investor to lock-in low valuations across the stock market for high-quality businesses that have the financial capacity to survive further operating challenges.

Over time, today's cheap stocks could experience stronger financial performances and improving investor sentiment that leads to high capital returns for investors.

A lack of passive income appeal elsewhere

Cheap dividend stocks offer a significantly more attractive passive income opportunity than other mainstream assets at the present time. For example, obtaining an income return that is positive on an after-inflation basis has become more difficult over the past year for bondholders and savers. They may even experience a loss of spending power should interest rates remain low and inflation rise in the coming years.

Meanwhile, property investment may produce disappointing income returns over the next few years. High house prices and a struggling economy may produce low yields that fail to improve significantly.

This may increase the appeal of cheap dividend stocks, thereby raising demand for income shares. The end result could be rising share prices – especially if interest rates remain at low levels. Since policymakers seem to be more concerned about the economy's outlook rather than maintaining modest levels of inflation, it would be unsurprising for a loose monetary policy to remain in place over the coming years.

Reducing risk from undervalued dividend shares

Of course, cheap dividend stocks may experience further difficulties in the short run. Their operating conditions could deteriorate further in the coming months. As such, it is important to buy those companies with solid financial positions and affordable dividends.

Doing so may reduce risk and lead to a higher passive income, as well as a larger capital return in a likely stock market rally over the long term.

Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on Share Market News

Stock market chart in green with a rising arrow symbolising a rising share price.
Share Gainers

Here are the top 10 ASX 200 shares today

It was a massive day for the ASX 200, with a new all-time high recorded.

Read more »

A man sits thoughtfully on the couch with a laptop on his lap.
Technology Shares

This ASX tech stock rocketed 60% in March! Can it keep on delivering?

After soaring in March, the ASX tech stock is now up 169% since this time last year.

Read more »

Broker Notes

Brokers name 3 ASX shares to buy now

Here's why brokers are feeling bullish about these three shares this week.

Read more »

A young man clasps his hand to his head with his eyes closed and a pained expression on his face as he clasps a laptop computer in front of him, seemingly learning of bad news or a poor investment.
Share Fallers

Why Burgundy Diamond Mines, Clarity Pharmaceuticals, EML, and Zip are sinking today

These ASX shares are ending the week in the red. But why?

Read more »

A young women pumps her fists in excitement after seeing some good news on her laptop.
Share Gainers

Why Mesoblast, Newmont, Pilbara Minerals, and Platinum shares are jumping

These ASX shares are ending the week strongly. But why?

Read more »

a young boy dressed up in a business suit and tie has a cute grin and holds two fingers up.
Opinions

2 of my top ASX 200 shares to consider buying before April

I would happily exchange dollars for these two shares right now.

Read more »

Father in the ocean with his daughters, symbolising passive income.
Dividend Investing

I'd spend $8k on these ASX 200 shares today to target a $6,102 annual passive income

I believe these ASX 200 shares will continue rewarding passive income investors for years to come.

Read more »

Three businesspeople leap high with the CBD in the background.
Share Market News

Boom! ASX 200 blasts to new record highs

ASX 200 investors just sent the benchmark index into uncharted territory.

Read more »