Beating Inflation with Dividends

Nov 01, 2021 | Marcia Zhou


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Considerations for dividend stocks

Canada's inflation rate rose to 4.4 percent in September to a nearly 20-year high. Some investors continue to believe that these current levels will be temporary and that long-term investors should look past the shorter-term noise and stick with their overall investment strategy. However, there will continue to be concerns regarding how long this inflation will last, with RBC CEO Dave McKay recently cautioning that “persistent inflation” is building up.

In the current low-interest rate environment, dividend-paying stocks have become an attractive investment to help beat inflation. As seen below, 2021 has been a great year for dividend-paying strategies and this performance could persist as total dividends are expected to continue growing.

 

What should you consider when searching for dividend stocks?

Investors should be looking to identify companies with the ability to increase their dividends consistently over the long term.  Generally, a company’s ability to return capital to shareholders is a positive sign of growth and free cash flow generation and could be an indication of a time-tested and reliable business model. Here are some other key things to consider.

Valuation: Although strong dividend growth is important, investors also need to consider current valuation multiples. How does a stock’s current valuation compare to its’ historical average?  The pace of dividend growth could taper off due to a myriad of reasons, and this could lead to a greater contraction for those with already stretched multiples.

Sectors: Some sectors benefit more than others from inflation. Potential winners could include sectors such as Financials, Energy, and Materials, whereas negatively impacted sectors may include Consumer Discretionary, Consumer Staples, and Utilities. Even so, the impact of inflation on a company is never black and white. Consideration needs to be made regarding their pricing power and their ability to pass higher costs to their consumers

Balance Sheets. Keep a close eye on company financials. If dividend growth is positive but is a result of increased financial leverage or an unsustainable payout ratio, then this could put pressure on the business in the future.

Apart from the above, one needs to monitor their sector and asset mix to ensure that no individual stock or sector has grown to a proportion that could render the portfolio unstable. Review with your advisor on how to align your portfolio to a higher inflationary environment and which dividend-paying stocks could be best to combat it.

 

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