The ’70s are coming back in a big way, and while that’s not so bad in fashion or music, it’s safe to say no one really wants that ’70s economy back. That was the decade that brought stagflation, a nasty mix of high inflation, rising unemployment and stagnant job growth. Economists had long thought that combination was impossible, but the Carter Administration’s economic mismanagement proved them wrong.
At least one top economist, Mohamed El-Erian of Allianz, sees a period of stagflation approaching, in the form of a global economic crash from which few countries will escape unscathed. As El-Erian sees it, inflation is too high and the Fed’s rate hikes are insufficient to contain it; the increases are more likely to stifle growth while forcing a contraction in the workforce. The result: short-term rising prices, rising unemployment and slow to nonexistent GDP growth, or in short, stagflation.
“Lower growth in the US and a late #Fed forced to raise 75 basis points for a record third consecutive time are consistent with global stagflationary trends. I wouldn’t be surprised to see further growth revisions,” El-Erian wrote.
It is a situation that calls for defensive measures from investors, with an emphasis on ensuring an income stream that offers some protection against inflation. In the world of stocks, that’s a recipe for dividend stocks.
We used the TipRanks platform to find a few dividend payers with strong buy ratings off the street and reliable dividends with a history of stable payments. And even better for defensive investors, both stocks have outperformed the general markets this year, with positive equity gains where the broader markets have fallen.
Merck & Co., Inc. (MRK)
We start with Merck, the well-known pharmaceutical company. This company is one of the giants in the world of Big Pharma, with a market cap of $218 billion and over $50 billion in annual revenue, of which about $22 billion came from the US market and $13 billion from the European markets. . Merck aims to make itself the world’s leading research-focused biopharmaceutical company and has an extensive clinical trial program, with 83 programs undergoing Phase II trials and a further 30 in Phase III.
Some of the more recognizable Merck products on the market today include Gardasil and the HPV vaccine used to protect women against cervical cancer, and Remicade, an antibody-based biological anti-inflammatory drug used in the treatment of autoimmune diseases such as Crohn’s disease and rheumatoid arthritis. Historically, Merck was the creator of the MMR (measles, mumps, rubella) vaccine that has become the standard for newborn babies.
The Big Pharma firms may have controversial reputations, but as Merck’s history shows, our medical system really needs them. And Merck has been driving that need for solid financial results. In the company’s recent report for 2Q22, revenue came in at $14.6 billion, up 28% year-over-year. That number included a 36% year-over-year growth in sales of Gardasil, to $1.7 billion, and a 26% year-over-year growth in sales of the anti-cancer drug Keytruda, which reached $5.3 billion. In terms of earnings, non-GAAP EPS was up 42% from the year-ago quarter to $1.87 per share.
The latter is an important metric, as earnings per share contribute to dividend affordability. Merck pays 69 cents per common share — so the EPS covers the payment in full — which comes out at $2.76 year-over-year. At that rate, the dividend yields a return of 3.2%. Merck has a 12-year history of both maintaining reliable payments and delaying dividend hikes.
With this in mind, it’s no wonder the company’s stock is up 16% this year, much better than the general markets.
All of this impressed Berenberg analyst Luisa Hector, who recently upgraded her stance on MRK shares, writing about the company: “For investors looking for a low-risk option in the pharmaceutical sector, we believe Merck & Co offers many benefits: mid-term growth just above the industry average, limited patent expiration charges, low exposure to US price reforms, margin expansion, and no lawsuit overhang. Revenue growth is heavily dependent on Keytruda and Gardasil, but we believe there are limited competitive threats…. We endorse the return of Keytruda cash flows in the form of dividends and redemptions. Merck & Co is our preferred name in large pharmaceuticals.”
Hector upped her rating for this stock from neutral to buy, and her $100 price target indicates she believes in upside potential of 15% in one year. (To view Hector’s record, click here)
The consensus rating, a strong buy based on 10 buys and 3 positions, clearly shows that Wall Street generally agrees with the optimistic views about this large biopharma company. The shares are priced at $86.64 and their average price target of $100.75 suggests a ~16% gain. (See MRK stock forecast at TipRanks)
American Electricity Company (AEP)
Let’s adjust the pace for the second stock and switch from biopharma to public utilities. American Electric Power is one of the largest electricity suppliers in the US, with more than 40,000 miles of transmission lines fed by more than 26,000 megawatts of generating capacity – a number that includes approximately 7,100 megawatts of capacity from renewable sources, and 5.5 million customers in 11 states. AEP, with its large presence in an absolutely vital economic niche, is an excellent example of a defensive stock, and in fact utilities have long had a reputation for being “recession proof.”
A look at AEP’s financial results shows that the company has done well so far this year, even if the first and second quarters both registered GDP declines. AEP had revenues of $4.6 billion, with non-GAAP operating income of $617.7 million. While year-over-year sales were relatively flat, revenues were up more than 28%. Non-GAAP EPS came in at $1.20, just one shade higher than a year ago result of $1.18.
In addition to good results, AEP reiterated its expectations for the full year 2022, with non-GAAP earnings expected between $4.87 and $5.07 per share. The company expects long-term growth of 6% to 7% in the future.
In a key performance measure, AEP shares are up about 16% this year, significantly outperforming the general markets.
Again, we’re looking at a company whose earnings fully cover the common stock dividend. The latest statement set the payment at 78 cents per share and was paid on Sept. 9. The current annualized dividend is $3.12 yielding 3.1%. However, the real key to this dividend is its extreme reliability. AEP prides itself on having paid a cash dividend in each fiscal quarter since 1910, making this most recent payment the company’s 449th consecutive quarterly payment. Few publicly traded companies can match that level of long-term dividend reliability.
One of the bulls is Morgan Stanley analyst David Arcaro, who sees AEP as a go-to among utility stocks.
“Utilities have outperformed the S&P by 20% this year. We think the space will hold its value in relative terms and may outperform slightly in the event of a weakening economic backdrop or a full-blown recession, as utilities tend to outperform after the earnings spike and after a recession kicks in. Valuations have risen, but we don’t see a clear case of the group being overpriced yet – valuations against the S&P 500, historical levels and bonds are all below previous highs in the last 10 years, so without an economic rebound we think the space is still fairly valued for its defensive properties. In the event of a recession, we expect low-risk names to outperform and prefer AEP,” explains Arcaro.
Therefore, Arcaro estimates AEP shares in an Overweight (ie Buy), along with a price target of $118, suggesting a one-year gain of 18%. (To view Arcaro’s track record, click here)
Overall, AEP has received 8 analyst reviews in recent weeks, including 6 Buys over 2 Holds, for a Strong Buy consensus rating from the street. (See AEP stock forecast on TipRanks)
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Disclaimer: The opinions expressed in this article are those of the recommended analysts only. The content is for informational purposes only. It is very important to do your own analysis before making any investment.