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Companies that distribute their profits to shareholders can be a great source of passive income. But dividend stocks can be tricky.
Interest rates in the UK have just hit 4%. That means investors can get a better return on their money than before by buying cash or bonds.
As a result, dividend investors must be selective in what they invest. With that in mind, here’s a UK dividend stock that I’m probably selling and thinking about buying.
Out: Experian
I have Experian (LSE:EXPN) stocks in my portfolio and I think it’s one of the best stocks in the FTSE 100. But I’m seriously thinking of selling them this month.
The company has limited competition, low capital requirements, and operates in an industry where barriers to entry are high. All this speaks of the quality of the business.
So why am I selling it? I just think there are better opportunities for me elsewhere at the moment.
Experian shares currently have a dividend yield of 1.3%. That’s not a problem for me in and of itself, but with interest rates at 4%, it needs to grow to be a viable investment.
The problem I have is that I don’t see where the required growth will come from. Neither Experian’s revenue nor its operating margin have grown rapidly over the past decade. Experian’s revenue has only increased about 4% per year for the past decade. And the slowdown in mortgage demand seems like another headwind to me.
The company’s competitive position seems likely to facilitate margin expansion. But Experian’s operating margins are lower than they were a decade ago.
Share buybacks could also boost dividends over time. But with buybacks reducing share counts by less than 1% per year, I think it’s hard to see this as a meaningful growth catalyst.
In: Diploma
Diploma (LSE: DPLM) shares currently come with a dividend yield of 1.8%. That’s higher than Experian and I think the company’s growth prospects are more promising.
The business has slightly higher capital requirements than Experian. But I think the returns that it generates on its assets are still very impressive.
My real reason for choosing Diploma over Experian as an investment opportunity is the growth of the company. The company’s revenues have been growing around 13% annually.
Compared to Experian’s 4%, that’s a significant advantage. And this difference has manifested itself in the dividends that shareholders have received. Diploma’s dividend per share has increased by 200% over the last decade. Experian has increased 68%.
Compared to Experian, Diploma does not have the same competitive position. I think that’s the biggest risk with this stock.
Not that Diploma is completely unprotected from competition, though. Their dominant positions in niche markets create barriers to entry for both larger and smaller rivals.
Invest in UK stocks
I’m not sure Experian offers the kind of return I’m looking for at 4% interest rates. I think it’s a great company, but I don’t see a return at today’s prices.
Diploma, on the other hand, seems to be offering better growth as well as better returns today. This is why I am looking to sell my Experian stake to add to my investment in Diploma.
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