On Wednesday, the January figures for inflation are due out in the UK. The previous figure from December was 5.4%, and the average expectation for this month is also 5.4%. On the one hand I might breathe a sigh of relief that the number isn’t expected to hit 6%. Yet at the same time, it’s clear that inflation isn’t falling to the target rate of 2% any time soon either. With that in mind, here’s how I’m trying to use top UK stocks to offset this erosion from inflation.
Picking up dividend payments
Firstly, I’m looking at dividend stocks that offer me a yield in excess of the current level of inflation. The average FTSE 100 dividend yield is 3.2% today, so it’s clear that I need to be going for the top UK dividend stocks here. Thankfully, there are many companies that I think could make smart investments for me.
For example, I could go for established names such as British American Tobacco and Rio Tinto. Both have a dividend yield above 6%. Further, both stocks have a long history of paying out dividends. Although I can’t guarantee that this will continue in the future, it does give me a good indication of the reputation of these dividend payers.
In theory, if I buy the stocks now and the dividend per share doesn’t change, the income I receive from the dividends will offset the impact of inflation. The risk with this method is that higher inflation can cause costs to rise for a business. This might mean it has to lower the dividend due to waning profitability.
Buying undervalued gems
The second way I’m thinking about using stocks is via undervalued picks. I could refer to these as ‘secret’ UK stocks. One way I can filter for this is by screening for low price-to-earnings ratios. As a tool, the lower the value usually indicates that a company is undervalued.
For example, both Royal Mail and JD Sports Fashion have current P/E ratios just above 7. This is around half the FTSE 100 average P/E. My thinking here is that if I buy these stocks now and over the course of the next year or more they return to a fairer value, the share price movement could eclipse 5.4%. So from the unrealised gains from my capital, I can help to offset inflation.
The risk with this idea is that the companies stay undervalued for a longer period of time than I was expecting. It could take years for the market to correct. Further, I might have made the wrong call, with investors not putting their money in these stocks for valid reasons that I’ve simply not appreciated.
Making use of top UK stocks
I need to think outside of the box if I want to generate a positive net return in 2022. Picking average or underperforming FTSE 100 stocks is only going to add to the drag from high inflation. Although I can’t guarantee returns, by using top UK stocks that have generous dividends or a low valuation I can give myself a better chance of coming out ahead.
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Jon Smith has no position in any share mentioned. The Motley Fool UK has recommended British American Tobacco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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