In an economic environment where inflation reached a 30-year record 5.4% in September, staying ahead of the inflation curve is on everyone’s mind. It must be noted that the September figure was not an isolated spike; the corresponding number for August was 5.3%. Leading the rise were food and energy, two non-discretionary areas of spending.
Whether it is fueled by supply shortages or the rising cost of labor, eventually investors are looking for a solution, in order that they do not end up with lower purchasing power because of the upward creeping inflation. The end of the inflationary spiral of oil and natural gas does not appear to be anywhere in sight, because of the shortfall in supplies.
Bill McMahon, managing director, and chief investment officer for active strategies at Schwab Asset Management, offers a solution to investors. In a recent interview, at the start of the third-quarter earnings season, he said, “You are seeing pricing pressures across the spectrum — labor shortages and supply shortages. We put a lot of that into our own thinking as we position our portfolios.”
He advocates looking for dividend paying companies with strong cash flows. In a way, this makes picking a simpler task, as it is mostly the strong brands that will answer to this description. He also sounded a warning and said that high inflation “may last longer than people expect.”
|AD - Recover your investment losses! Haselkorn & Thibaut, P.A. is a national law firm that specializes in fighting ONLY on behalf of investors. With a 95% success rate, let us help you recover your investment losses today. Call now 1 888-628-5590 or visit InvestmentFraudLawyers.com to schedule a free consultation and learn how our experience can help you recover your investment losses. No recovery, no fee.|
Though lying second from bottom in terms of performance on the S&P 500 Index SPX year to date (YTD), at 6.5% only ahead of Utilities which has delivered 4.9%, Consumer staples is a sector he is currently recommending, that has several companies that display the characteristics he favors, pricing power along with strong brands.
Investors should be aware of economic cycles and how today’s star might not be the right horse to back for a longer-term investment. As an example, Energy, which at 54.7%, far and away the leader in terms of YTD returns, driven by rising global demand as well as supply shortages and disruptions, has been the poorest performer over a 10-year period, with negative returns for a good part of the last 5 years.
According to McMahon, the S&P 500 is as good a starting point as any for identifying stocks that have a history of paying dividends, and also seem to possess the cash flows to be able to not only sustain but even increase the payouts. A number of stocks that populate this list are likely to be ones that have popular recall, or popular consumer brands, in other words.
He recommends a method for a more objective evaluation. His recommendation is a comparison of the target company’s free cash flow, or cash net of planned capital expenditure, which is the amount that can be used by the company for initiatives that could benefit shareholders, such as increased dividend payouts, share buyback programs or even plain old business expansion, yield, with its current dividend yield. Free cash flow yield can be obtained by dividing the free cash flow by the current share price.
If you do this evaluation for the free cash flow in 2022 and arrive at the free cash flow yield, and if that yield is lower than the present yield, the company is probably maxed out and does not possess room for growth. But, if higher, it does and could be a good target for investment.
The strategy executed, in simple steps
- Exclude real estate investment trusts (REITs) as well as financial companies
- Of analysts polled by FactSet, 22 agree on free cash flows for 360 companies
- Of these 360, 265 pay dividends
- Remove the top quintile from this set. According to McMahon, “Sometimes really high yields can be somewhat illusory.” This will possibly cleanse the list of:
- some troubled companies
- companies with slower growth
- companies that could cut dividends in the next few cycles
- The lopping off of 20% brings the list down to 212. AT&T Inc., Lumen Technologies, and Kinder Morgan Inc. are examples of stocks that got removed on account of this strategy.
Though it was not the intention, several companies that own popular brands find themselves on it, such as Pepsico, Johnson & Johnson. Procter & Gamble Co., Colgate-Palmolive Co. and Mondelez International Inc.
It should also be noted that the leader in this list. Clorox, while topping the list for yield, is at the bottom when you look at estimated free cash flow headroom for 2022.
Having created a shortlist of interest, it would be advisable for investors to do further research in order to understand the stock better before investing. There is a wealth of information available for free on the net, such as the detailed guide produced by Tomi Kilgore. Analysts will also have opinions on most of these stocks. So, if there are analysts you trust, seek their opinions as well.
Dividend Paying Stocks to Beat Inflation
|Ticker||Company||Dividend Yield||YTD Return||3-Year Return|
|JNJ||Johnson & Johnson||2.60%||4.10%||30.10%|
|PG||Procter & Gamble||2.40%||5.40%||97.60%|
|BBY||Best Buy Co||2.50%||14.60%||72.00%|