Dividend shares: 1 to buy and 1 to sell

Dividend shares can be great investments. But not all of them are equal. Stephen Wright examines the growth prospects of two of his UK stocks.

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Companies that distribute their earnings to shareholders can be a great source of passive income. But dividend shares can be tricky.

Interest rates in the UK 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 need to be selective in what they invest in. With that in mind, here’s a UK dividend stock I’m likely selling and one that I’m thinking of buying.

Out: Experian

I own Experian (LSE:EXPN) shares in my portfolio and I think it’s one of the best stocks in the FTSE 100. But I’m looking seriously at selling them this month.

The company has limited competition, low capital requirements, and operates in an industry where barriers to entry are high. All of this speaks to the quality of the business.

So why am I selling it? Quite simply, I think there are better opportunities for me elsewhere at the moment.

Experian shares currently have a 1.3% dividend yield. That isn’t a problem for me by itself, but with interest rates at 4%, it needs to grow in order to be a viable investment.

The issue I have is that I don’t see where the required growth is going to come from. Neither Experian’s revenue nor its operating margin has been growing rapidly over the last decade. Experian’s revenue has only increased by around 4% per year over the last decade. And slowing mortgage demand looks like another headwind to me. 

The company’s competitive position seems like it ought to facilitate margin expansion. But Experian’s operating margins are lower than they were a decade ago.

Share repurchases could also boost dividends over time. But with buybacks reducing the share count 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 1.8% dividend yield. That’s higher than Experian and I think that the company’s growth prospects are more promising.

The business has slightly higher capital requirements than Experian. But I think the returns it generates on its assets are still very impressive.

My real reason for preferring Diploma to Experian as an investment opportunity is the company’s growth. The company’s revenue has been growing at around 13% per year.

Compared to Experian’s 4%, that’s a significant advantage. And this difference has manifested itself in the dividends shareholders have received. Diploma’s dividend per share has increased by 200% over the last decade. Experian’s has increased by 68%.

Compared to Experian, Diploma doesn’t have the same competitive position. I think that’s the biggest risk with this stock.

It’s not as though Diploma is entirely without protection from the competition, though. Its dominant positions in niche markets create barriers to entry for both bigger and smaller rivals.

Investing in UK shares

I’m not sure that Experian is offering the kind of return I’m looking for with interest rates at 4%. I think it’s a great company, but I don’t see the return at today’s prices.

Diploma, on the other hand, seems to be offering better growth as well as better returns today. That’s why I’m looking to sell my stake in Experian to add to my investment in Diploma.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has positions in Diploma Plc and Experian Plc. The Motley Fool UK has recommended Experian Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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