The short – but boring – answer to the question in my headline is… it depends. The closer I am to retirement, the more it makes sense for me to look to dividend shares as a source of passive income.
But this only raises a further question. At what point should I look to shift my focus from growth companies like Diploma (LSE:DPLM) to income stocks like Unilever (LSE:ULVR)?
2 UK shares
Both Diploma and Unilever are terrific companies, but they’re very different. This is illustrated by their recent growth rates.
Over the last decade, Diploma’s revenues have increased by just under 15% a year. And the firm’s looking to keep growing through acquisitions, the latest of which is Peerless Aerospace Fastener.
Revenues at Unilever, by contrast, have grown by around 3% a year. And the company’s looking to expand its margins by divesting some of its weaker brands and less profitable divisions.
Diploma’s clearly on a much faster growth trajectory. And this is arguably why the stock comes with a 1.5% dividend yield, compared to 4% for Unilever shares.
10 years
Over the last decade, Unilever’s increased its dividend per share by an average of 5%. If it can keep doing this, the stock makes a lot of sense for investors seeking passive income in the next 10 years.
A £1,000 investment today will return £62.05 in 2034 if the dividend continues to grow at 5% a year. And the possibility of reinvesting the dividends means there’s scope to do even better.
By reinvesting at the current 4% yield for a decade, a £1,000 investment could eventually generate £88.32 a year. That compares favourably with what might be expected from Diploma.
If Diploma continues to grow its dividend at the current 13% rate, a £1,000 investment could return £45.06 after 10 years. And reinvesting at the current 1.5% yield only increases this to £51.52.
25 years
The equation is quite different for an investor with a 25-year outlook though. If Diploma can keep growing at its current rate, the extra time really makes a difference.
Despite reinvesting at a 1.5% dividend yield, 13% annual growth means a £1,000 investment in Diploma could be returning £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 leads to 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, the growth stock looks like a better investment.
Growth vs dividend shares
UK shares can be great opportunities. But investments are never without risk – Diploma’s acquisition strategy brings a risk of overpaying and inflation could be a long-term challenge for Unilever.
Importantly, investors also need to think carefully about their own ambitions before deciding which to invest in. And how long they plan on owning the shares for is a key part of this.
These are specific examples, but I think something similar is true in general. The closer I get to retirement, the more I plan to focus on the passive income dividend shares provide.
