Inflation is not transitory and will be with us longer than is being reported. Rapidly rising inflation is forcing investors to deal with macroeconomic and market conditions they haven’t seen in decades, cautions Kelley Wright, editor of Investment Quality Trends.
Rising prices threaten growth, corporate earnings, and equity returns. Now that we have shone a light on the situation, what does the enlightened investor do to address it?
Here is some good news, you already know what to do. Dividend-paying stocks provide strong protection from inflation as well as offer solid long-term return potential, if you know how to identify high-quality and understand when that high-quality offers good value.
Sure, I get it, dividend-paying stocks are not what immediately come to mind when looking for high risk-adjusted returns, because truth be told they haven’t exactly set the world on fire in an easy-money, liquidity fueled environment.
There is also the stigma that dividend-paying stocks are old, dull and boring, vanilla companies, like utilities or consumer staples that offer limited growth potential. Sexy sells, and nothing is sexier than high-flyers like technology, the “gig” economy and other internet growth companies. I mean seriously, who wants to hang out with the old guys when there’s these hip, slick and cool alternatives?
The thing is, the QE Era was an anomaly, a foray into make believe if you will. Adding insult to injury, now that the everything bubble has burst, investors who blindly poured into the rage de jour missed out on the fact that high-quality dividend paying stocks actually delivered superior risk-adjusted returns over the QE period and are holding up much better in this bear market.
Identifying high-quality, good value, dividend-paying stocks requires having a set of repetitive measures that separates the good from the bad and the ugly no matter the current economic environment. The reason for this is that dividends reflect a company’s ability to generate consistent free cash flows to distribute to shareholders.
Today, especially, investors need to know that the cost inflation and growth pressures that threaten low-quality companies won’t squeeze the margins and threaten the dividend payouts of their companies.
This provides the perfect segue to highlight the importance of our criteria for Select Blue Chips. Our universe of blue-chips stocks is relatively small in comparison to the total number of stocks that trade on the various exchanges, but that is by design, we want quality, not quantity.
We have a lot of computer power at IQ Trends and access to more data and information than anyone could possibly digest. That being said, just because we have the means to sift through giant reams of data and information doesn’t mean it is required to be successful in the stock market.
Limiting our focus to just those companies that meet the minimum requirements of our criteria for Select Blue Chips has been more than adequate to generate competitive, if not superior returns to the broader stock market for over five decades.
Obviously, in the throws of a bear market, our Undervalued category is growing on a steady basis. This is what happens when prices decline. Personally, I welcome these opportunities because they allow for finding great companies across all the major sectors, which in bull markets is often difficult, if not impossible to do.
In our view, the optimum portfolio consists of 25 to 30 companies that are diversified equally among the 9 to 10 industrial sectors from the Undervalued category. In addition, we maintain a list that we call The Timely Ten, which represent our top ten current recommendations from the Undervalued category.
To identify these Undervalued stocks — that also have excellent internal economic measures — we focus on return on invested capital, free cash flow, free cash flow yield and the price to value ratio. Based on these metrics, here are our current Timely Ten:
Cass Info Systems (CASS) — yielding 3.11%
GSK, plc (GSK) — yielding 6.07%
Novartis AG (NVS) — yielding 4.40%
Rio Tinto plc (RIO) — yielding 12.98%
Altria (MO) — yielding 6.24%
Dow, Inc. (DOW) — yielding 6.24%
Eastman Chemical (EMN) — yielding 4.24%
Morgan Stanley — (MS) — yielding 3.95%
Tyson Foods (TSN) — yielding 2.87%
Amgen (AMGN) — yielding 3.34%
In closing, for all the times you said I wish I had more Undervalued stocks to choose from, now is your time. This is when world-class portfolios diversified across the major industrial sectors are built. For the value investor, now is when the world is your oyster.