Something has happened recently that has never happened before in the market. If you take the current inflation rate and compare it to the earnings and dividend yield of the S&P 500, you get a number that’s essentially close to zero, he explains. Justin Carbonneau, editor at Valid.
This means that the total implied expected return of the S&P 500, including capital gains and dividends, is lower than current inflation. On a real basis, you could lose purchasing power if prices rise and stocks fail to return higher than potential inflation. (This was pointed out on the investment blog SentimenTrader and in Barron’s.)
More from Justin Carbonneau: Dividend Aristocrats: Value and Yield in Times of Inflation
This is not a great situation for investors who buy the S&P 500 and expect returns, especially those who rely on income and growth, if we are in a sustained inflationary environment.
But not all hope is lost. Stay with me for a moment to understand why.
One possible solution is to look for consistent, higher-than-average long-term dividend payers and combine that search with quality and value in and effort to deliver more returns than what the broader market can offer you.
Quality value during inflation times
In a recent piece by GMO, the investment firm advocated quality and quality value, especially during periods of higher inflation.
Specifically, they note:
“High quality stocks have beaten the S&P 500 in six out of eight inflation periods.”
High-quality, cheaper stocks beat the S&P 500 in seven out of eight inflation periods.
This would make sense, as many high-value companies are more profitable entities. Because inflation affects profits, quality companies are better able to absorb cost increases.
When you add value, you most likely get higher returns due to higher expectations in interest rates, making value stocks, which are valued more in short-term cash flow (vs. growth stocks and long-term cash flow flows), more valuable based on their income stream.
Importance of Dividends
What if we combined our high-value value idea with high-dividend stocks?
This is where the dividend aristocrats come into play, but with a twist.
On Validea, we run a predefined screen that identifies the dividend aristocrats. The aristocrats are companies that have paid and increased their dividends for 25 consecutive years – no small feat!
Of course, for many investors who keep it ultra-simple, the ProShares S&P 500 Dividend Aristocratic Cra (NOBL) is a great option, but as we can see from our ETF Factor Report on Validea, many of the holdings are not that cheap based on traditional value metrics.
From dividend aristocrats to dividend kings
Using our factor scores and guru models, I wanted to see if I could better represent high quality and value when looking at the Dividend Aristocrats and point out names that might give us a better chance in times of inflation (playing off GMO’s research that shows quality exceeds value).
Using the Dividend Aristocrats as a starting point, I used both our value and quality composite scores, which rate all companies based on sub-factors such as return on equity, gross and net margins, sales, and EPS consistency for quality and valuation metrics such as the P/E, P/B, P/S, P/CF and EV/EBITDA for value.
I then combined the value and quality composite into a combined ranking. From there, I looked for names that have a strong interest from at least two of our gurus-based models, which gives me a degree of confidence that the stock exhibits fundamental attractiveness based on investment strategies that have been tested and over the course of time. work the time.
As you’ll see in the list below, it’s an eclectic mix of stocks from a wide variety of sectors in the market. The average P/E of the 11 stocks is just 20, which is reasonable and the average dividend yield is 2.5%:
aflac (AFL) – yields 2.4%
IBM (IBM) — returns 4.4%
Target (TGT) — returns 3.1%
Franklin Resources (BEN) — returns 3.3%
T. Rowe Price Group (TROW) — yields 2.2%
Lowe’s companies (LOW) — returns 1.7%
Archer-Daniels-Midland (ADM) — yields 2.3%
walmart (WMT) — yields 1.5%
PepsiCo (PEP) — yields 2.9%
Cincinnati Financial (CINF) — returns 2.1%
Johnson & Johnson (JNJ) — yields 2.6%
In addition, if we get inflation, having a quality value tilt will probably be important, as highlighted by the GMO research. Moving up the dividend aristocratic hierarchy doesn’t require too much work if you know what to look for.
Investors looking for quality, value and growing and consistent dividends can use the dividend aristocrats as a starting point and then incorporate other variables as I did to capitalize on those stocks that may have attractive investment qualities and characteristics.
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