Dividend stocks are everywhere in the UK. As home to some of the oldest businesses in the world, the London Stock Exchange is filled with income-generating opportunities for investors to capitalise on. And in some cases, these firms look primed to continue paying out to shareholders for years or even decades to come.
High-yield opportunities are certainly nice to explore. But often, the best long-term income investments actually stem from lower-yielding businesses with the capacity to keep hiking payouts over time. That’s what’s brought both RS Group (LSE:RS1) and Diploma (LSE:DPLM) onto my radar this month.
Critical supply lines
RS Group and Diploma have similar business models. But they target different niches of their addressable market, allowing for both to thrive largely without stepping on each other’s toes.
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As a quick reminder, these firms operate as middlemen in their customers’ supply chain. Instead of businesses directly sourcing components and materials from producers, they can turn to companies like RS and Diploma to handle all these headaches for them.
These businesses establish relationships with thousands of suppliers to source the components their customers need for various projects. As technology’s become increasingly complicated, finding components has become even more challenging. And that’s proven to be a powerful demand tailwind for solutions offered by the likes of RS and Diploma.
With that in mind, it’s hardly surprising that these firms now cater to businesses operating in a vast array of industries, including manufacturing, automotive, electronics, aerospace, energy, and biotech.
Challenges of cyclicality
Despite both companies expanding their market share over the years, performance over the last few quarters has been fairly muted. On the back of higher inflation and interest rates, projects and manufacturing contracts have been getting delayed.
This has been especially prominent in the consumer electronics space, which RS Group has a greater exposure to. And the impact of this downward cyclicality in demand is made clear by the stock’s price taking a 10% hit since the start of 2024.
Cyclicality’s nothing new to these businesses. Their respective management teams have experience navigating volatile economic conditions. Nevertheless, it’s a threat that will remain moving forward and one which, in extreme cases, could compromise dividends.
The income opportunity
Looking at the dividend yield today, RS Group currently offers 3.1% while Diploma sits at 1.3%. Needless to say, neither sounds particularly exciting. Even more so, given the FTSE 100 sits at 3.6%. However, the low yield may only be temporary.
RS Group’s been hiking shareholder payouts for eight years in a row so far, with an average annual growth rate of 8.3%. Meanwhile, Diploma’s track record of continuously increasing dividends sits at over two decades with a growth rate of 16.9%!
Assuming these trends continue, today’s mediocre yields could grow substantially, given enough time. Obviously, there’s no guarantee of that happening, especially if either firm ends up suffering from a prolonged cyclical downturn that compromises earnings.
However, even with this risk factor, I doubt demand for simplified supply chains is going to fall out of fashion anytime soon. That’s why, despite the risks, I’m tempted to snap up both stocks for my income portfolio once I have more capital at hand.
