Five dividend stocks to beat inflation

Rupert Hargreaves looks at five stocks to beat inflation that should help protect your wealth

Smirnoff stand
Diageo, maker of Smirnoff, has some of the best gross profit margins in the FTSE 100
(Image credit: © Rob Kim/Getty Images)

Finding the best dividend stocks to beat inflation isn’t as easy as it sounds. But owning income shares with prices rising could be a sensible decision for investors.

According to research from Goldman Sachs, during periods of high inflation (greater than 5%), dividend stocks tend to do better than the wider market. The investment bank’s research is based on data for equities in the S&P 500 index going back to 1940.

A deeper look into the data only reinforces this conclusion. In the 1970s, a period of very high inflation in the US, the S&P 500 delivered total returns of 77% of which three-quarters was attributable to dividends and dividend reinvestment.

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The data also shows that dividends can be an important component of total returns even in a low-inflation environment. Dividends and reinvested dividends have made up about half of the total returns of the MSCI AC World Index over the past two decades.

However, not all income stocks are created equal. Some companies are better positioned to deal with pricing pressure than others. Here are five dividend stocks that look best-placed to deal with rising inflation.

Dividend stocks to beat inflation

At the top of the list is FTSE 100 beverages giant Diageo (LSE: DGE).

Companies with the most pricing power are in the best position to pass on rising costs to consumers, and there are few corporations in the FTSE 100 with the same kind of pricing power as Diageo.

The company’s portfolio of brands, which includes premium and non-premium products such as Guinness, Smirnoff Vodka and Johnnie Walker whisky, means it has distribution across a number of price points and international markets.

With its substantial economies of scale and buying power, Diageo also has some of the best gross profit margins in the FTSE 100 providing a high level of protection against inflation to the firm’s bottom line. Companies with fatter margins are better positioned to absorb higher costs.

These qualities help Diageo stand out to me as being one of the best dividend stocks to beat inflation despite growing economic headwinds. The stock offers a 2.2% yield.

Rising commodity prices are driving inflation

Rising commodity prices are one of the main reasons why inflation has exploded over the past couple of months. One of the main beneficiaries of this boom is Glencore (LSE: GLEN). The miner and commodity trading house is virtually unrivalled in terms of size and scale in this market. It has access to information and pools of capital other companies can only dream of.

With its vast resources, it is able to take advantage of commodity pricing differentials in markets around the world. For example, if it can buy coal for $100 a tonne in one country and sell it in another for $105, Glencore will do just that.

With trading profits booming, Glencore thinks it will earn $3.2bn from its trading business this year, that’s at the high end of management’s expectations. And the longer these commodity market disruptions last, the longer the group will be able to earn abnormal profits.

Glencore has shown a willingness in the past to return excess profits to investors when it can, and that’s what analysts believe it will do this year.

Refinitiv analyst estimates have the stock yielding 8.9% this year and 8.5% in 2023. Additional cash returns could be on the cards in the form of buybacks as the company continues to earn bumper profits.

A dividend champion rising from the ashes

A company that might not be the first point of call for investors looking for income stocks to beat inflation is Phoenix (LSE: PHNX). This firm manages pension policies for over 13 million customers with just under £270bn of assets between them.

Phoenix has grown by acquiring books of closed pension policies, which other companies are trying to offload. By aggregating these assets, the group can streamline operations, reduce costs and earn a return on investment. It also branched out into the more conventional retirement savings market with the acquisition of Standard Life Aberdeen's insurance arm in 2018. Today, this is a key area of growth for the business.

Unlike other peers in the sector, such as Aviva (LSE: AV) and Legal & General (LSE: LGEN), Phoenix does not offer general insurance on cars or properties. Instead, it focuses exclusively on managing pensions and long-term savings products.

This focus on one product line (the group is also almost entirely based in the UK) might put some investors off from owning the stock. While I understand this viewpoint, I also think this business has some great qualities for an inflationary environment.

Phoenix does not manage the assets it holds to meet liabilities itself. It outsources this work (to keep costs low) and the managers have a mandate to invest these assets to deliver predictable returns. That’s very important when you’re talking about people’s life savings.

The company also hedges its business against inflation. In its latest results release the firm stated that the current inflationary pressures will have no material impact on its financial performance.

All of this means Phoenix has the hallmarks of a stable and predictable business, with stable and predictable cash flows. Indeed, management has calculated that the firm can generate £17bn of cash over the coming years. After stripping out expenses and other costs, the group reckons it will have £12bn of available cash to return to investors (excluding the impact of any acquisitions).

The stock currently yields 7.9%.

Defensive dividend stocks to beat inflation

A recurring revenue stream is a great advantage for any business, even more so if growth is built into that income stream. Long-term commercial rental contracts are a great example of repeat revenue streams and most commercial leases have clauses allowing for rents to be reviewed at regular intervals. This is very valuable in an inflationary environment.

Primary Health Properties (LSE: PHP) owns hundreds of medical facilities, mainly health centres and GP surgeries across the UK and Ireland. Five-year rent reviews are built into most of the company’s leases and the majority of its revenue comes from government agencies. I don't think you could find a more secure, inflation-proof income stream than that.

Structured as a real estate investment trust (Reit), Primary Health supports a dividend yield of 4.6%.

A defensive play with inflation-beating credentials

Utility Severn Trent (LSE: SVT) benefits from both an inflation-linked recurring income stream and a unique asset base that will only grow in value as prices rise, two qualities that make it stand out as one of the best dividend stocks to beat inflation.

Inflation will increase the value of the firm’s assets, such as pipes and treatment plants, which are costly and time consuming to replace.

What’s more, inflation will also reduce the value of the group’s debt in real terms. That should lead to an overall improvement in net gearing. Net gearing currently stands at around 60%, and 69% of this is fixed-rate borrowing.

The company is regulated by Ofwat, meaning it cannot raise prices as it sees fit, but the regulator is still allowing for growth. Severn Trent is offsetting higher costs elsewhere through cost-saving measures such as energy self‑generation, which now meets 50% of its needs.

These measures should allow the business to continue to grow its payout throughout the rest of the current regulatory period, which lasts until 2025. The stock offers a dividend yield of 3.6%.

Disclosure: Rupert Hargreaves owns shares in Diageo and Phoenix Group.

Rupert Hargreaves

Rupert was the former Deputy Digital Editor of MoneyWeek. He's an active investor and has always been fascinated by the world of business and investing. 

His style has been heavily influenced by US investors Warren Buffett and Philip Carret. He is always looking for high-quality growth opportunities trading at a reasonable price, preferring cash generative businesses with strong balance sheets over blue-sky growth stocks. 

Rupert has freelanced as a financial journalist for 10 years, writing for several UK and international publications aimed at a range of readers, from the first timer to experienced high net wealth individuals and fund managers. During this time he had developed a deep understanding of the financial markets and the factors that influence them. 

He has written for the Motley Fool, Gurufocus and ValueWalk among others. Rupert has also founded and managed several businesses, including New York-based hedge fund newsletter, Hidden Value Stocks, written over 20 ebooks and appeared as an expert commentator on the BBC World Service. 

He has achieved the CFA UK Certificate in Investment Management, Chartered Institute for Securities & Investment Investment Advice Diploma and Chartered Institute for Securities & Investment Private Client Investment Advice & Management (PCIAM) qualification.