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The short but boring answer to my headline question is… it depends. The closer I am to retirement, the more sense it makes for me to consider dividend stocks as a source of passive income.
But this only raises one more question. At what point should I look to change my approach to growing companies like Diploma (LSE:DPLM) to income stocks like Unilever (LSE: ULVR)?
2 UK stocks
Both Diploma and Unilever are great companies, but they are very different. This is illustrated by its recent growth rates.
Over the last decade, Diploma's revenue has grown just under 15% annually. And the company is looking to continue growing through acquisitions, the latest of which is Peerless Aerospace Fastener.
Unilever's revenue, by contrast, has grown around 3% annually. And the company is looking to expand its margins by shedding some of its weaker brands and less profitable divisions.
It is clear that the diploma is on a much faster growth trajectory. And this is arguably why the stock has a 1.5% dividend yield, compared to 4% for Unilever shares.
10 years
Over the past decade, Unilever has increased its dividend per share by an average of 5%. If it can continue to do this, the stock makes a lot of sense for investors looking for passive income over the next 10 years.
An investment of £1,000 today will generate £62.05 in 2034 if the dividend continues to grow at 5% per year. And the ability to reinvest dividends means there's room to do even better.
By reinvesting at the current 4% yield over a decade, an investment of £1,000 could return £88.32 a year. This compares favorably with what you might expect from Diploma.
If Diploma continues to grow its dividend at the current rate of 13%, an investment of £1,000 could return £45.06 after 10 years. And reinvesting at the current 1.5% yield only increases this to £51.52.
25 years
However, the equation is quite different for an investor with a 25-year outlook. If Diploma can continue to grow at the current rate, the additional time really makes a difference.
Despite reinvesting at a 1.5% dividend yield, 13% annual growth means a £1,000 investment in Diploma could generate £402.86 in passive income after 25 years.
Unilever's lower growth means its expected return is lower, despite the opportunity to reinvest at a higher rate. Reinvesting £1,000 at 4% only generates a return of £330.68 with 5% annual growth.
Assuming growth rates and dividends remain the same for both companies, Diploma's returns eclipse Unilever's after 21 years. After that, growth stocks look like a better investment.
Growth vs Dividend stocks
UK stocks can be great opportunities. But investments are never risk-free: Diploma's acquisition strategy carries the risk of overpaying and inflation could be a long-term challenge for Unilever.
Importantly, investors should also think carefully about their own ambitions before deciding what to invest in. And how long they plan to own the stock is a key part of this.
These are specific examples, but I think something similar happens in general. The closer I get to retirement, the more I plan to focus on the passive income that dividend stocks provide.
