High dividend yields could become increasingly popular among UK investors. After all, they provide an income return which is in excess of inflation. And with the prospect of a higher rate of inflation in the medium term, dividend yields which have significant headroom versus inflation could seem highly attractive.
That’s partly why Capita (LSE: CPI) may appear to be a strong income stock at the present time. The company has a dividend yield of 6.9%, which is among the highest returns available at the moment. However, there could be another stock which proves to be a superior income play over the long run. It may have a lower yield, but its dividends could be more secure and could grow at a faster pace in future years.
The company in question is transport specialist National Express (LSE: NEX). It reported an upbeat trading update on Monday which showed that its trading conditions remain strong. The company has a relatively diverse business model, with it operating in a range of different geographies. This position has been strengthened via two recent acquisitions. One is in the US, while the other is in Spain. Both are small, but could deliver returns in the region of 15%-20% over the long run.
Christmas trading in the UK and Spanish coach businesses has been strong. Trading has been in line with expectations since its last update. This means that it is expected to meet guidance for the current year, with its earnings due to rise by 6% this year and by a further 9% next year. This could help to push dividend payments higher – especially since they are currently covered 2.1 times by profit.
National Express’s business model appears to be relatively robust. It has generated double-digit earnings growth in each of the last two years. With its future prospects being upbeat, it may therefore offer a more robust income outlook for investors than is the case for Capita. This could mean that while its 3.6% dividend yield is lower than that of its index peer, it may be more reliable and could grow at a faster pace for investors in the company.
Capita, of course, faces an uncertain future. Its industry outlook is difficult to predict, with demand being relatively low for its services. This could negatively impact on its financial performance and on the rate of dividend growth. As well as this, the company is in the process of changing its business model. Asset disposals could rejuvenate its bottom line, but with earnings forecast to fall by around 14% this year its near-term outlook appears to be rather challenging.
As such, and while Capita could deliver a successful comeback and generate a high income return, National Express may prove to be the better income stock. It seems to have lower risks as well as the potential for a faster-rising dividend in future.
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Peter Stephens has shares in National Express. 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.