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When the price of Macdonald’s Big Mac is rocketing, you can be sure that inflation is back. In the US, it was reported recently that the iconic burger now costs $6.05, on average with some variations across states. That’s 7.2% higher than a year earlier – the biggest jump since 1981, according to the National Restaurant Association.
And the problem doesn’t only apply to burgers: across the world inflation is rising. To give one estimate, the International Monetary Fund expects inflation to average 5.7% in advanced economies during 2022, roughly a third more than it was forecasting just a few months ago.
So, what can investors do? In some European countries and the United States, inflation is at its highest level for 40 years. That means it may be time to go back to the basic tenets of investing, remembering that ultimately investors value stocks for the dividends they pay.
Historically, dividends have proved a good hedge against inflation. At times when inflation has risen, so too have dividends. The explanation is intuitive: in periods of inflation, most companies can also raise the prices of their goods or services, and as such increase nominal earnings. This then translates into higher dividends.
Past performance is not a reliable indicator for future performanceSource: http://www.econ.yale.edu/~shiller/data.htm. Data from January 1881 to March 2022, in USD. Inflation calculated as 10-year annualized US CPI growth, Dividend growth is 10-year annualized growth in S&P 500 weighted dividends.
It’s also worth remembering that, over time, dividends have been the main driver of equity returns. Simply comparing the US S&P 500 index’s performance including dividends or excluding dividends shows this to be the case. The power of dividends is clear.
Past performance is not a reliable indicator for future performance Source: Bloomberg, data from 31 December 1927 to 30 April 2022, in USD.
Of course, not all companies paying out high dividends are equal. The risk in so-called high income stocks is that a company pays out an unsustainably high proportion of its earnings to shareholders in the form of dividends. Why is this a risk? Because eventually the company can no longer afford to pay its dividend, disappointed shareholders sell and the price falls.
Our VanEck Dividend ETF invests in the 100 shares with the current highest dividend yields globally. To avoid pitfalls, though, we screen them for resilience. We do so by only including those shares where less than 75% of earnings are expected to be paid out as dividends. This buffer has helped to avoid surprises. However, investing is subject to risks, including the total loss of capital.
Our approach has been rewarding. In fact, over the past five years investors have received an annual income yield of 4% or more, alongside a respectable total return. Please note that past performance is not guarantee of future results.
Past performance is not a reliable indicator for future performance Source: Bloomberg, data from 20 May 2016 to 06 May 2022, Gross Total Return in EUR.
Now back to that Big Mac. For burger lovers and investors alike, high inflation is something we haven’t seen for a long time. That’s why the comfort of a tried and tested burger – or the proven formula of investing in solid companies with high dividend payouts – might be the best way to ride this out.
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