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Why I’d avoid Capita plc and buy this 6% dividend yield instead

At first glance, fallen star Capita (LSE: CPI) looks to be a great dividend stock. City analysts are calling for the company to pay a dividend of 31.7p per share for 2017, giving a current yield of 5.5%.

With earnings per share of 50p also projected, the shares look cheap trading at a forward P/E of 11.4. 

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However, even though Capita might look like an attractive dividend investment on the face of it, I believe that the company has nothing on another dividend champion, which currently offers investors a yield of 6%. 

The market’s best income stock? 

Kier (LSE: KIE) flies under the radar of most investors, but that doesn’t mean you should ignore this opportunity. 

As a leading UK building and civil engineering contractor, which also specialises in private house building, Kier’s fortunes are tied to those of the UK economy. And right now, business is booming. 

At the end of September, the group reported underlying pre-tax profit growth of 8% to £126m, on revenue of £4.27bn, up 5% year-on-year for the fiscal year ending 30 June 2017. Meanwhile, the acquisition of engineering services provider McNicholas in July boosted the order book to £9.5bn from £8.9bn and made it a top-three player in the utility sector.

City analysts are expecting further growth next year. Earnings per share growth of 11% has been pencilled in for the financial year ending 30 June 2018. These forecasts indicate that the shares are trading at a forward P/E of 9.4. More importantly for income investors, the shares yield 6.4%. 

Struggling to recover 

As Kier grows, Capita struggles. Last month, the company reported that its bid pipeline shrank to £3.1bn, from the £3.8bn in March, with £403m of significant contract wins in the period – less than half compared to the same period last year, as the contract win rate fell to 1-in-2 from 1-in-3. For the first six months, reported revenue declined 1% and at the reported level, profit before tax shrank 25% to £27.6m. 

According to management, full-year pre-tax profits will be supported by cost-saving initiatives, which are expected to produce a net benefit of £57m by the end of next year. However, management has also warned that some trading businesses were “not improving as quickly as expected“, which is likely to slow recovery. 

The bottom line 

All in all, Capita’s falling win rate and declining revenues indicate to me that the company might not return to its former glory for some time. This is bad news for dividend investors. While there may be no immediate threat to the payout, dividend growth may remain elusive for the foreseeable future. 

On the other hand, as long-term income play, Kier looks to be the better buy. The company’s prospects are bright, which indicates to me that the payout will grow in the years ahead. Also, the stock is currently inexpensive, and the yield on offer is nearly double the market average. 

You can't succeed without dividends 

Kier looks to me to have all the hallmarks of a top dividend stock. That's why I believe it's a better buy for your portfolio than Capita.

It's essential that you own a portfolio of dividend stocks if you want to generate the best returns on your cash. Indeed, research has shown that over the long term, dividends account for half of equity returns.

For tips on how to get the most out of dividends, I highly recommend that you take a look at this free report titled The Foolish Guide To Financial Independence.

The report is entirely free and available for download today

Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.