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Should Investors Be Considering Dividend-Paying Stocks?

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With inflation hugging 40-year highs, the possibility of a recession looming in the not-too-distant future and constantly shrinking portfolio values, many of us are losing our appetite to spend.

Whether it is the Conference Board or the University of Michigan, consumer surveys are telling the same story: Americans are incrementally cautious about the near future, about job prospects, their income growth and the business environment.

According to the university, “consumers across income, age, education, geographic region, political affiliation, stockholding and homeownership status all posted large declines” (in sentiment). Food and gas inflation in particular appear to be “eroding living standards.”

According to the Conference Board, “Purchasing intentions for cars, homes and major appliances held relatively steady—but intentions have cooled since the start of the year and this trend is likely to continue as the Fed aggressively raises interest rates to tame inflation. Meanwhile, vacation plans softened further as rising prices took their toll.”

The board finds that consumer sentiment about the present situation has changed marginally (the present situation index went from 147.4 in May to 147.1 in June). But it is their expectation about the future (i.e. the next six months) that has changed dramatically: the expectations index continued its downward trajectory from 73.7 to 66.4 from May to June. This is the lowest level since the 63.7 recorded in March 2013.

Rising inflation in essentials and rising interest rates to combat it will keep the pressure on sentiments, for sure.

But while all of us are entering this uncertainty together, we will not all be exiting it in the same way. Some will be cutting all spending and hoarding cash. Some will be investing in essentials and commodities since they tend to hold relatively steady in bear markets. And some will look for bargains in the stock market.

Stocks have outdone most other asset classes in recent history and at the cheap valuations to which many of them have sunk, they are certainly worth building strategies around.

Today, I’m focusing on investors looking for income generating stocks. These are stocks that pay a dividend. The main reason a company pays a dividend is it generates more earnings that it can invest back into the business.

This is usually because it is a mature player, but can also be because it operates in an industry where further growth in the near future is limited for some reason. It supports its stock price and investor interest by paying dividends. During a bear market, or a recession, dividend-paying companies are therefore incentivized to pay more dividend.

A few things need to be kept in mind, however, when investing in these stocks.

First, ascertain that the company’s growth outlook is sound, even if it is likely to be impacted by the current uncertainties. This can be done by choosing stocks in the top 50% of Zacks-classified industries. Our research shows that the top 50% outperforms the bottom 50% by a factor of 2 to 1. This will point you toward the industries that appear to be battling the uncertainties better than others.

Second, revenue growth is the real indicator of quality earnings. It ensures that the earnings growth is really coming from more business and not just production efficiencies or accounting jugglery. Therefore, it’s worth checking out what’s happening with revenues, if possible. Analyst revenue expectations for up to a couple of years are usually available. Although these are moving numbers and liable to change as analysts update their expectations, they are worth checking out.

Third, in order to lower your risk, ascertain that the debt/total capital ratio is low, say under 40-50%. If a company falls into very hard times, it will still be required to pay its debt obligations. So, the lower this is, the better.

Fourth, check the dividend yield and how far the dividend has grown in the last few years. This gives you an idea of what to expect.

Fifth, make sure you choose stocks that have Zacks #1 (Strong Buy) or #2 (Buy) ranks, because our research has shown consistently that this is where most of the action will be in the near term.

Finally, be sure to buy cheap. For example, the price based on earnings potential should be relatively lower than the past year (for example) and also preferably lower than a benchmark, say the S&P 500.

Here are a few stocks that satisfy the above criteria:

The RMR Group, Inc. (RMR - Free Report)

This provider of business and property management services in the U.S. belongs in the top 37% of Zacks-classified industries. It also carries a Zacks Rank #1. RMR’s current dividend yield is 5.63% while dividend growth over the last five years is 11.6%.

Revenue growth expectations for the company are 22.6% and 2.9% in its current and following fiscal years (ending September). RMR has no long-term debt. The shares also trade at 12.5X earnings, which is below their median level over the past year and the S&P 500’s 16.4X.

Nippon Yusen Kabushiki Kaisha (NPNYY - Free Report)

This provider of marine, land and air transportation services worldwide is in the top 18% of Zacks-classified industries. Moreover, it carries a Zacks Rank #2. These two factors in combination are normally enough to indicate upside in the shares.

But since we are concerned with dividend growth potential, it’s worth looking at Nippon Yusen’s other numbers as well. And so, we see that analysts expect the company to grow revenues by 25.2% in the current year ending in March 2023 followed by 17.4% growth the following year.

Nippon Yusen pays a dividend that yields 22.17%. Its dividend has grown 125.9% over the last five years. The Debt/Cap of 32.0 is totally manageable. At 1.3X earnings, the shares are well below their annual highs.

Petroleo Brasileiro S.A. - Petrobras (PBR - Free Report)

Zacks #1 ranked Petrobras explores for, produces, and sells oil and gas in Brazil and internationally. The industry to which it belongs is in the top 25%. What’s more, its dividend which currently yields 25.92% has grown 104.04% in the last five years.

Petrobras’ revenues are expected to grow 32.1% this year. While a decline is currently forecasted for the following year, the direction of analyst estimate revisions is encouraging. Debt/Cap of 34.9% isn’t a cause for concern. P/E of 2.9X is lower than its median value over the past year.

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Petroleo Brasileiro S.A. Petrobras (PBR) - free report >>

The RMR Group Inc. (RMR) - free report >>

Nippon Yusen Kabushiki Kaisha (NPNYY) - free report >>