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Valuations are stretched! 5 great stocks to grab now! A crash is coming! Inflation will eat our returns! Buy and hold! Well which is it? And how can we protect ourselves if things really do go to hell in a hand basket? What kind of investments are best right now? One idea is quality dividend stocks. Why? For the reason that dividend stocks fight inflation. In addition, the right ones can be had at a reasonable price, offer rising income and be good bets for thriving in the ups and downs of the market.
The case for dividend stocks
Well managed companies are able to grow their earnings year after year. If they have more cash than they can profitably invest in the business, they sometimes return it as dividends to the shareholders. The most confident businesses increase those dividends each year. Those that have raised their dividends consistently for the last 25 years are called Dividend Aristocrats.
Here are some benefits of dividend stocks:
- The dividend aristocrats have outperformed the broader market by 1.7% a year over the last 30 years
- The rising stream of dividends can provide income in retirement without having to sell in down years
- The dividends can be reinvested to buy more stock. This can be done automatically in a dividend reinvestment plan (DRIP)
- Automatic reinvestment of dividends means that you will buy more as the stock price dips and buy less as the price rises, improving your overall investment. This fact can actually bring you joy when stocks fall. An important psychological benefit.
- A dividend growth rate that is above inflation provides income that rises faster than inflation. In this way, dividend stocks fight inflation.
- A stable and growing dividend tends to smooth out stock price variations
What else should we look for in stocks in these crazy times?
Stocks have taken off like, well, fighter jets since Covid hit. Part of that has been from rising earnings. However a much bigger factor has been that stocks have simply become more expensive. As an example, the Price Earnings multiple (how much you pay for $1 of earnings) has doubled since Covid began. So a big fear is that something will scare the market and share prices will plunge. What could cause that? A war. A scary security breach. Political unrest. Who knows? But we’re not exactly buying on the cheap right now.
So ideally, we should look for stocks that:
- Has a long history of rising dividends
- Low risk of a dividend cut
- Is cheap relative to the market
- Is likely to fly smoothly in turbulent times
- Has a stable, deep pocketed set of customers
- Benefits from rapidly changing technology
That’s a challenging set of criteria and it begs the question…
Are there any stocks that can deliver on that mission?
One example is Lockheed Martin (LMT), a major global security and aerospace company. They have increased their dividend for 20 years in a row. Given their business model, they are literally and figuratively likely to fly smoothly in turbulent times. In fact, they may well benefit from the turbulence. And I like the idea that they employ 114,000 of the brightest people on the planet. All working hard to add value and increase the value of the company and its shares. They do this while I play some guitar, ride my bike or binge Netflix. Bless them.
Looking back their performance has been stellar. From January 2011 to January 2021, the stock has risen from $83 to $336. Not bad! The dividends have also grown, from $0.75 to $2.60. Those numbers sound impressive, but what do they mean?
To illustrate, say you had you invested $10,000 in Lockheed Martin in January of 2011. Ten years later you would be sitting on $40,386. Nice 4 bagger! But that isn’t the whole story. Over that period you would have also received a total of $8,129.05 in dividends. But the real fun would have happened if you would have reinvested all of your dividends. That would have left you with a total of $68,326.51. An average growth of more than 21% a year. Whoa! The right dividend stocks fight inflation with both a rising stock price and rising dividends. As an example, the stock alone has grown an average of almost 15% a year, while the dividends grew by more than 13% a year. Both well ahead of inflation which averaged about 2% over the period.
And incredibly, LMT is cheap, with a price earnings multiple of just 15.26, or about 1/3 the price of the overall stock market (S&P 500).
Back to the checklist
So how does Lockheed look relative to our checklist?
- Has a long history of rising dividends – yep 20 years and counting
- Low risk of a dividend cut – they pay out a low 40% of their earnings in dividends
- Is cheap relative to the market – about 1/3 the cost of the market
- Is likely to fly smoothly in turbulent times – they wrote the book on it
- Has a stable, deep pocketed set of customers – the US government as well as other allies and civilian customers
- Benefits from rapidly changing technology – Obsolete defense gear is a great reason to replace everything
The Summary
There are always solid investments available. The key is to take the time, select quality companies with strong management and a history of rising earnings. Dividend growth companies can add some stability and income to a portfolio as we have seen. Investors should always build a well diversified portfolio that aligns with their risk profile.
Lockheed Martin stock was outlined here for illustrative purposes as an example of a dividend growth stock. Plus it gives me a cool blog feature image. There are plenty of other stocks to consider as good long term investments. Defense company stocks can also be purchased as an Exchange Traded Fund (ETF), allowing exposure to other firms in the space including Northrop Grumman and McDonnell Douglas. There are also ETFs that include only dividend aristocrats such as the SPDR S&P Dividend ETF (NYSE:SDY) or Vanguard’s Dividend Appreciation Fund (NYSE:VIG).
Investors should always do their own research or consult with a qualified investment advisor prior to investing. Past returns are not a guarantee of future performance. The author holds a position in LMT.
What are your thoughts on dividend stocks? Which ones are your favorites?
Related: The 5 Big Reasons Why Your Investments Aren’t Growing as Fast as Warren Buffett’s