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Better Buy: Dividend Aristocrats vs. Beaten-Down Tech Stocks

The broader market decline over the past five months has left the S&P 500 at a year-to-date loss of 23% and has no doubt left many investors questioning the solidity of their portfolios. If you're considering making changes to your investments, or happen to be on the sidelines holding a bucket of cash (good for you), you might find yourself asking what to do next and how to best put your hard-earned dollars to use.

The answers to those questions all boil down to an investment strategy. Some of you may prefer the comfort of dividends, while others opt for riskier, beaten-down tech stocks that boast massive growth potential and are currently trading at bargain prices. Which route is the better buy for you?

Image source: Getty Images.

The case for Dividend Aristocrats

Dividend Aristocrats have the distinction of having increased annual dividends for 25 consecutive years. These companies also belong to the S&P 500, an index that has produced average annual returns of 10.7% dating back to 1957. So, focusing on this group can have the potential to produce a significant level of capital appreciation along with the comfort that annual dividends are likely to increase over time. As dividend payouts grow, investors that choose to reinvest dividends can benefit from additional compounded earnings.

But how much passive income can dividends really generate? One easy way to know how much you can receive in annual dividends is to view the company's dividend yield. For every $100 of investment you make in a company's stock, your annual dividend will be equal to the yield number.

The table below shows what that looks like for a sample of Dividend Aristocrat stocks -- IBM (NYSE: IBM), ExxonMobil (NYSE: XOM), General Dynamics (NYSE: GD), and Walgreens Boots Alliance (NASDAQ: WBA) -- representing various sectors.

Company Share Price Per-Share Annual Dividend Dividend Yield Annual Dividend with a $100 Investment Annual Dividend with a $10,000 Investment
IBM $135 $6.60 4.85% $4.89 $489
Exxon $ 86 $3.52 4.09% $4.09 $409
General Dynamics $210 $5.04 2.40% $2.40 $240
Walgreens $39 $1.91 4.86% $4.90

$490

Data Source: Yahoo!Finance as of June 20, 2022.

During times of broader market volatility and downward pressure, various sectors may perform better than others in annualized returns. For example, research conducted at George Mason University shows that during periods of high inflation and rising interest rates, Energy and Materials stocks outperform other sectors, offering annualized returns of 18% and 16%, respectively. This may impact your strategy about how to invest in dividend stocks.

Savvy investors who trust their own portfolio-management skills may opt to make adjustments that align with market trends in order to optimize capital appreciation and dividends. But for many long-term investors who would be satisfied with a 10.7% average annual return from the S&P 500, choosing Dividend Aristocrats with the highest annual dividend and the longest streak of consecutive annual increases may be the way to go.

The case for beaten-down tech

In looking at the current list of Dividend Aristocrats, you might notice that one sector appears to be largely unrepresented: technology. In fact, only two of the 65 companies listed -- Automatic Data Processing and IBM -- are in technology. This isn't terribly surprising, though, because such companies often choose to invest money back into themselves for future innovation and growth.

The technology sector as a whole is down 12.7% over the past year and down 28% year to date. Companies like Apple (NASDAQ: AAPL) and Amazon (NASDAQ: AMZN), whose stocks have respectively dropped 25% and 42% over the past year, are arguably top dogs in the tech space, but neither offers much in the way of dividends. Apple's current annual dividend is only $0.92 per share, while Amazon doesn't pay a dividend at all.

There are, of course, pros and cons to forgoing dividends entirely or only producing minimal ones. On the one hand, no- and low-dividend companies have more to reinvest in innovation and future growth. On the other hand, dividends can keep investors engaged enough so that stock drops are relatively minimized. Without shelling out a dividend incentive to investors, companies stock prices may be exposed to more drastic dips.

But where these beaten-down tech stocks offer investors excitement is in the tremendous growth potential in revenue and earnings, which can lead to huge capital appreciation through share-price growth. The 10-year average annualized return for the S&P 500 information technology sector is 16.9%, which outpaces that of the broader index's 14% average annualized return over that same time period and far outpaces the 10.7% lifetime average of the S&P 500.

But if you look at leading tech companies like Apple or Amazon, the share-price growth over that same 10-year period is an astonishing 487% and 881%, respectively. That level of return, which comes along with the risk of huge drops along the way (as evidenced by the past year), can certainly make up for lack of dividends.

The last time Apple and Amazon stocks dropped by as much as 25% was in 2018. After that, both went on a three-year climb resulting in over 100% gains before the current bear market. And since 1950, the S&P 500 has rebounded with an average 24% growth a year after entering bear market territory -- which we're in now.

Which is right for you?

Determining which is the better buy depends on your investment strategy. Dividend Aristocrats and beaten-down tech stocks can all provide returns to help meet investors' goals. If you're more risk-averse, or at a point in life where generating income is important, then perhaps going with Dividend Aristocrats would better suit your needs. But if you're willing to take the risks of volatility for the potential reward that comes from growth generated by advancements in innovation, the beaten-down technology sector can provide buy-low opportunities that can increase gains over the long term. Some investors may opt for a mix of both.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeff Little has positions in Amazon and Apple. The Motley Fool has positions in and recommends Amazon and Apple. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.


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