Prior to the 1980’s it was common to assume that a stock’s value was derived from the discounted present value of estimated future dividend payments. Using that model, investors still had to make estimates for how profitable the company will be in the future, how stable the dividend payments will be and what discount rate should be used; however, it was easier to understand how a stock’s price was derived. Not all stocks paid dividends prior to 1980 it was much more common than it is today.

During the 1980s and 1990s, as quantitative analysis became more popular, alternative theories arose that suggested that estimates of future dividend payments did not fully explain a stock’s current price. This change helped create a shift in attitude among investors: dividends don’t matter, and growth is the primary factor driving a stock’s value.

This shift in investor sentiment can be seen in historical trends of dividend yields. Aside from the all time lows in the late 90’s and early 2000’s, dividend yields have never been lower than they are today. The average yield from stocks included in the S&P 500 hovers near 2% per year. Like most things in the market, the value (or lack thereof) of streams of dividend payments is hotly debated. Shareholders and management have conflicting interests in the debate and it is a subject that should be explored.

During periods of market volatility there is a great case to be made that dividend payments can reduce account volatility and increase returns. Take for example the Morningstar Dividend Leaders Index. It has an annualized return of over 6% over the last 10 years, which is much better than either the S&P 500 or the Russell 2000 over the same period. The lower relative volatility can be attributed to the stream of reinvested dividends or payments.

An important lesson to learn here is that sometimes investors completely overlook the value of a dividend payment stream on a stock chart. For example, Coca-Cola Company (KO) was trading for about $53 per share in September 2000 and recently the stock was worth $57.26, which would seem to represents a pretty anemic 7.5% gain for the last 10 years – or does it? If you adjust the stock’s price for dividend income the actual return has been 50%, which is not bad considering the overall return on the major stock indexes over the same period.

However, I would suggest that this debate is a little misguided. It assumes that investors must choose between dividends or growth. That is probably not the case. While it is true that many “growth” stocks pay low or no dividends on average, there are plenty of exceptions for investors looking for the best of both worlds. It seems entirely reasonable that income and growth can exist side by side.

There are several ways to developing a portfolio of stocks that pay dividends. You can search for and pick individual stocks that have shown the ability to grow in value and pay a dividend at the same time. It may also make sense to just select an ETF that indexes dividend paying stocks rather than building the list yourself. For example, the iShares dividend index fund (DVY) trades like a single stock, but represents a large list of dividend paying stocks.

Finding and buying dividend paying stocks is very similar to the process of buying any other stock. Besides screening for a good dividend yield, you should look for good fundamentals, sales and profit growth and a strong trend. Ultimately you will need to decide whether this additional criteria requirement is important to your investing objectives. We think that you will find some ‘old-school’ dividend-based stock analysis can really pay off in the long run.