Capital growth & dividend income: Avoiding overvaluation

There will be times when investing for capital growth is the right option: when you have a long time to invest, and when you can weather market volatility. However, there will be times when a more balanced and diversified investment portfolio is right: this is where a portfolio that prioritises income as well as growth can work well.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

While this type of balanced portfolio can be appropriate at any time, it may be particularly important for investors at or near retirement. Investors in later life might need an income from their savings to support their day to day living. However, they may not want to give up on the capital growth potential provided by stock market investment, which can be a useful tool in defending long-term savings against erosion by inflation. This is the type of circumstance when investing for dividend income as well as capital growth can be a better option.

Diversification and asset allocation may not fully protect you from market risk.

There are other reasons to look at investments that balance income and capital growth. Historically, income has been an important part of the total return from investments, particularly in certain markets, such as the FTSE 100.¹

Why Income is more consistent than growth

Income is often a more consistent form of returns than capital growth. Capital returns can be volatile and are at the mercy of short-term changes in market sentiment. However, dividends are determined by company management teams. UK companies have grown their payouts to shareholders consistently over the past five years, at the same time as share prices have bounced around.²

Companies with a history of paying consistent or growing dividends tend to be more financially stable. After all, they need to generate sufficient cash to pay out a dividend and have strong balance sheets with lower debt.³ This applies across small, medium and large companies.

Paying a dividend can also be an important sign of company management’s confidence in the future of the business.

Income could also provide an important cushion during volatile markets. A loss of 15% during a period of market turmoil may hurt less if an investor knows they are getting 5% in dividends. This could provide more risk averse investors with some reassurance and help keep them invested in choppier moments.

Should you combine investing for income and growth?

While income is important, marrying it with capital growth could help investors avoid ‘value traps’. This is where companies appear to be good value, but their business is deteriorating. Where companies have a very high dividend, it can be a sign of distress and the market may believe it will cut its payout to shareholders. Targeting companies with capital growth potential could reduce this risk.

Also, investing for income and growth can often deliver a more balanced and diversified portfolio, allowing investors to explore different sectors and themes. Only focusing on growth or income can lead investors to certain parts of the market – technology on one side, for example, or heavy industry on the other - and may leave their portfolios looking unbalanced.

The combination of income and capital return can be powerful. Over 20 years, an original investment of £10,000 delivering a return of 3% per annum from dividends increases in value to around £18,200.^4,5 On its own the dividend income from an investment can deliver a handsome long-term total return. But by combining the income with some growth in the share price, the impact of compounding is even more profound. If an investment compounds at 6% for 20 years, it turns £10,000 into nearly £33,100.^6,7

The longer the time horizon, the more profound this effect can be. Equity returns will not be delivered as smoothly as illustrated here, but it demonstrates the power of compound returns over time. In this way, combining income and growth can help investors beat inflation and preserve the purchasing power of their savings.

Where do you find income and growth opportunities?

Investing for income and growth is not an either/or decision. Higher growth companies may also pay a dividend. The income opportunity has diversified – it used to be that only large, mature businesses would pay dividends, but now income can be found in smaller companies, in emerging markets, and in higher growth sectors such as technology.

Since the start of 2024, Meta and Alphabet have joined three of their Magnificent Seven peers – Microsoft, Apple and Alphabet as income stocks.⁸ In Asia, technology giant Alibaba started paying a dividend this year, while TenCent and semiconductor giant TSMC also pay dividends.⁹

Emerging market companies also increasingly prioritise dividends. The BlackRock Frontiers Investment Trust and the BlackRock Latin American Investment Trust both pay a dividend yield, for example.^10,11 Even though neither trust targets income as an output, companies in these markets tend to be cash generative and pay dividends.

The UK market also has a range of companies paying dividends. It can be worth looking beyond larger companies. UK income strategies focused on larger companies may have a diversification problem, with income drawn from a handful of companies and sectors.

The small and mid cap sectors are often overlooked by income investors and yet can provide a potential solution to this diversification problem. Smaller companies may be overlooked when looking for dividends, but there are dividend options available. The BlackRock Smaller Companies fund is one of the AIC’s Dividend heroes – awarded to companies with that have increased their dividends each year for more than 20 years.¹²

To find these smaller companies that can grow their income over time, the BlackRock Smaller Companies team focus on certain factors that indicate a company’s quality. Companies need strong cash flow, for example, a sound business model, strong competitive advantages and a capable management team to sustain and grow their payouts to investors.

Overall, investors need to be confident that a company can grow its dividend over time. That means having the cash flows to back future growth. A strong analyst team could find pockets of undiscovered growth and income, where the market still has to catch up to the opportunity.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

There can be no guarantee that the investment strategy can be successful and the value of investments may go down as well as up.

Income and growth opportunities with BlackRock

The narrow focus of stock markets in recent year on a handful of large technology companies has left areas that were traditionally thought of as growth investments overlooked by investors. In many cases, these areas could also pay an attractive dividend. Among the BlackRock range of investment trusts, this includes areas such as frontier markets or smaller companies.

Our trusts also invest in a range of income markets with long-term growth potential. This includes selective investments in the Latin American and UK markets. By combining capital growth and income targets, it can be possible to find strong long-term growth companies and capture the best of both regions.

This is an exciting time to be an income investor. The focus on a handful of high growth companies has seen many interesting growth opportunities overlooked by investors. These growth opportunities increasingly pay an income as well. Investors don’t have to choose between income and growth, but can find a range of opportunities that combine both.

Sources:

¹ IG Index - What are the average returns of the FTSE 100? - March 2025
² AJ Bell - Dividend dashboard - April 2025
³ LSEG - Small-cap dividend growth advantage - 21 January 2025
⁴ London Stock Exchange, FTSE All Share, 13 June 2025
⁵ This is Money, long term savings calculator, 13 June 2025
⁶ MSCI - MSCI World index - 4th June 2025
⁷ This is Money, long term savings calculator, 13 June 2025
⁸ The Motley Fool - 5 of the "Magnificent Seven" Stocks Pay a Dividend - 30 April 2024
⁹ Portfolio Adviser - Analysis: Faith in equity income stocks starts to pay dividend - 17 March 2025
¹⁰ The AIC, BlackRock Frontiers investment trust, 13 June 2025
¹¹ The AIC, BlackRock Latin American investment trust, 13 June 2025, The AIC
¹² Trustnet - The newest entrant to the AIC’s ‘Dividend Hero’ list - 17 March 2025

Risk Warnings

Investors should refer to the prospectus or offering documentation for the funds full list of risks.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time and depend on personal individual circumstances.