Investors who bought British American Tobacco (LSE: BATS) shares five years ago have already received 32% of their investment back in dividends. That’s a lot.
By contrast, investors who bought shares in Bunzl (LSE:BNZL) have received less than 14% of their initial outlay back. But that doesn’t tell the full story.
Dividends
While British American Tobacco has sent out a lot of cash to its shareholders, the total return has been much lower. This is the result of a falling share price.
The firm has sent out £10.51 per share. But the stock is down by £3.89, which means investors who bought the stock at the end of 2019 are actually up £6.62 per share.
At the end of 2019, the share price was £32.66, so £6.62 translates into a return of just over 20%. That’s worse than the FTSE 100 over the same time period.
It’s natural to think that the dividend should be the main focus for investors looking for passive income. But investors should be wary of falling into a trap here.
Growth
Bunzl’s dividend has been much lower, but it has more than made up for this with growth. As earnings have gone from £1.05 to £1.56, the stock has climbed 55%.
This has allowed shareholders to sell part of their stake to generate cash. In this way, they’ve been able to match the 42% distributed by British American Tobacco.
Furthermore, investors who bought Bunzl shares have been able to do this while still having an investment worth more than they paid for it. This is important.
A stock doesn’t have to pay a dividend to create a passive income opportunity – growth can do this just as well. But there are risks with either strategy.
Risks and rewards
With British American Tobacco, the product that makes up most of its revenues is probably in terminal decline. So the durability of the dividend is questionable.
This doesn’t automatically make the stock a bad choice. But investors need to be confident they’re going to get enough in distributions to offset the business contracting.
Bunzl’s operation is growing, rather than shrinking. But with a 2% dividend yield, the firm needs to find enough growth to be able to generate a return for investors.
The key is finding enough acquisition opportunities. If it can’t it will be hard for the company to maintain the kind of returns it has managed over the last five years.
Total return
Shares with high dividend yields can be attractive for passive income investors. But a growth stock that lets investors take cash out can be just as good.
Ultimately, investment results are the same whether they come directly from the company or by investors selling shares. Either can provide a cash return.
This post was originally published on Motley Fool
