It's official — inflation is back in town. Specifically, the Consumer Price Index (CPI) jumped to 4.2% in April after remaining below 3% since the second half of 2011.
There are many reasons to worry about inflation. It eats away the value of your cash, raises your cost of living, and puts pressure on the companies in your investment portfolio. But while inflation might seem like an all-powerful enemy, you can fight back. One strategy is to invest in premium dividend stocks.
The equity inflation hedge
Stocks are a good inflation hedge because their growth rates outpace inflation over time. Long-term, stocks grow about 10% annually on average. Inflation, on the other hand, averages about 3%.
Unfortunately, long-term stock price appreciation doesn't help you manage higher living expenses in the short term. Dividend stocks help with that problem by paying out some of your returns in cash.
Meet the Dividend Kings
Even better, some dividend stocks have reputations for increasing their shareholder payments every year. That's appealing in any economic environment, but a rising dividend is particularly useful in inflationary times. If your paycheck or Social Security income isn't keeping pace with rising prices, ever-increasing dividend payments can chip in to help.
The most dependable dividend payers are in an exclusive club called Dividend Kings. To be a Dividend King, a company must have increased its shareholder payments for 50 or more years consecutively. That's an accomplishment available only to mature, established organizations.
A lengthy track record of dividend increases doesn't mean the trend will continue forever. But it does mean the leadership team is probably motivated to stick with a rising dividend as long as possible. Even so, dividends require profits and cash. If those things dry up, so will the dividend increases.
Dependable dividend stocks
The table below shows five Dividend Kings that have yields above 2% and payout ratios below 70%. Payout ratio is the percentage of a company's earnings that it pays out as dividends. This is an indication of the company's ability to sustain its dividend. Lower is better — anything above 75% warrants further research.
Also shown below is the percentage increase of each company's most recent dividend raise — all are above 3%.
Current Dividend Yield
Most Recent Percentage Increase
Procter & Gamble (NYSE: PG)
Clorox (NYSE: CLX)
Genuine Parts Company (NYSE: GPC)
Hormel Foods (NYSE: HRL)
Johnson & Johnson (NYSE: JNJ)
More dependability metrics
In addition to payout ratio, other metrics that can signal dividend dependability are debt-to-equity ratio, net profit margin, and earnings forecasts.
Debt-to-equity ratio. The debt-to-equity ratio is long-term debt divided by shareholder equity. It is a measure of leverage. Higher leverage is riskier because it means the company has a bigger debt balance to service. Debt repayments use cash, which limits funds available to pay shareholders.
A debt-to-equity ratio above 2 is high, though there are mature companies that operate with far more leverage. Home improvement retailer Lowe's (NYSE: LOW), also a Dividend King, has a debt-to-equity ratio over 15.
Net-profit margin. Net profit margin is the percentage of sales that are left after expenses have been paid. A higher margin signals a more efficient operation. Operational efficiency adds some cushion with respect to profit-making.
A double-digit margin is ideal, but this varies from sector to sector. Retailers, for example, have low margins. Walmart (NYSE: WMT) has a net profit margin of about 3%, but still generates plenty of cash to fund its dividend.
Earnings forecasts. A history of profitability doesn't always translate to a future of profitability. Pay attention to analyst forecasts before and after you invest in a Dividend King. You'll want to know if the outlook turns south. A negative earnings outlook could be bad news for the dividend.
Kings for crushing inflation
You can fight back against inflation with dependable dividend stocks. And historically speaking, Dividend Kings are among the most reliable dividend payers out there. But do your research. If inflation settles in for a time, that's a factor all these Kings must manage. You want to own the companies that are positioned to keep funding those dividend increases, no matter what.
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Catherine Brock owns shares of Johnson & Johnson and Procter & Gamble. The Motley Fool recommends Johnson & Johnson and Lowes. The Motley Fool has a disclosure policy.