The Case For Dividend Growth Stocks For Inflation & Recessions

by | Jun 28, 2022 | Blog


Written by Jonathan Weber for Sure Dividend.

Rising interest rates, high inflation, and fears about a potential recession in the coming quarters have made for a couple of rough months for equity markets. But even during bear markets and market crashes, not all equities behave equally. Some stocks decline less than others, or may actually see their shares rise as investors flock to safe-haven assets.

Dividend growth stocks can belong to those equities that outperform during times of high inflation or recessions, especially when one chooses them carefully. For example, the Dividend Aristocrats have proven themselves during past recessions by raising their dividends for at least 25 years in a row.

Dividend growth stocks are a special class of equity that raise dividends every consecutive year. In order to qualify for Dividend Aristocrat or Dividend King distinction, the company has raised its dividend 25 consecutive years (Aristocrats) or 50 consecutive years (Kings)

When one seeks even longer and more powerful track records, choosing among the Dividend Kings is another option. Those are companies that have managed to raise their dividends for at least five decades in a row. The dot.com bubble bursting, the Great Recession, and the pandemic did not hinder these companies in providing safe and growing income for investors.

By investing in these Dividend Aristocrats and other high-quality dividend growth stocks, investors can reduce their portfolio volatility. Due to the safe and growing income streams that these stocks promise, investors can also weather market downturns better from a psychological perspective. This helps investors keep calm during days when the market declines, and importantly also helps avoid mistakes such as selling at the lows in a bear market.

The reliable income stream coming from dividend growth stocks also allows for continuous dividend reinvestment during market panics, which adds to one’s income stream in the future as investors are able to buy quality stocks at attractive prices with the cash they receive from their dividend growth portfolio. 

For investors that live off the income that their portfolios generate, such as retirees, the dividend growth aspect is important as well. During inflationary times, when personal expenses seemingly go up every month, owning an income stream may not be enough to guarantee one’s lifestyle needs are met. Instead, opting for an income stream that has a high likelihood of continuing to grow over time is a better idea, as it helps insulate against the dangers of inflation. In the current environment, that is more important than it has been for several decades.

Due to these factors, we do believe that searching for dividend growth stocks that can do well during the current environment — high inflation and a potential recession — can be an opportune choice for investors. We will now present three dividend growth stocks that are worthy of further research due to their characteristics.

1: Johnson & Johnson

Johnson & Johnson (JNJ) is a high-quality dividend growth stock that has raised its payout for an incredible 60 years in a row. The company is diversified across pharmacology, medical tech, and consumer staples, with all three of these industries being resilient versus recession. Thanks to strong brands and the fact that healthcare needs have to be met no matter what, Johnson & Johnson has a lot of pricing power that helps protect the company against inflation. The company’s AAA-rated balance sheet is ultra-strong and reduces risks further.

Johnson & Johnson offers a dividend that yields 2.6% at current prices and that has just been raised by 7%. With the payout ratio not standing at an especially high level, and with further earnings-per-share growth being very likely in the coming years, investors can count on ongoing dividend growth in the mid-to-high single digits. Combined with the dividend yield, this should allow Johnson & Johnson to generate total returns in the 8%-10% range in the long run. Johnson & Johnson is not the highest-yielding income stock by far, but it is a very reliable, low-risk choice that can be very suitable for risk-averse investors.

2: Exxon Mobil

Exxon Mobil (XOM) is a leading oil and gas company that is diversified across production, refining, and marketing. On top of that, the company has a vast chemicals business that provides some additional diversification. In times of low oil prices, Exxon Mobil’s profitability declines. But in the current environment, when energy products are scarce and when inflation is running at multi-decade highs, Exxon Mobil is in a comfortable position where its profits are soaring and where it generates massive cash flows that can be used for shareholder returns. The company has raised its dividend 39 years in a row, which underlines that its management has a clear long-term focus aimed at creating shareholder value over many years.

Exxon Mobil is currently trading at only 8.2x forward earnings, which is one of the lowest valuations in many years. On top of that, the recent pullback in its shares has made Exxon Mobil’s dividend yield rise to a pretty nice 4.1%. Since the dividend will take up only around 30% of this year’s profits, investors can expect a meaningful dividend increase later this year. For investors that are more worried about inflation than a recession, Exxon Mobil could be a good pick.

3: Realty Income

Realty Income (O) is a triple-net lease REIT that primarily invests in retail properties. Its tenants include drug stores, post offices, dollar stores, etc. which is why the company is very resilient versus recessions, unlike retail REITs that own malls, where lower consumer spending is a major risk.

Realty Income employs considerable debt to finance some of its property acquisitions, which is why the company is a solid inflation hedge. When inflation is running higher than its cost of debt, which is the case today, debt gets essentially inflated away, thereby creating value for shareholders as the underlying properties become more valuable.

In past recessions, Realty Income has performed very reliably. This includes the pandemic, where Realty Income managed to hit new record profits in both 2020 and 2021, far surpassing most other retail-focused REITs that experienced profitability declines in that time frame.

Realty Income’s strong past performance during good times and bad times and its dividend that yields 4.5% today, combined with a dividend growth track record that spans 26 years, makes the company an attractive low-risk higher-yielding income stock in the REIT space.

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