Let us be frank here. Inflation is really looking uncomfortable now. At 4.2%, the UK’s year-on-year inflation is at its highest in almost 10 years. As a macro investor, I am now considering how to make the most of my investments now that prices are high.
How inflation impacts my FTSE 100 investments
Inflation could impact my investments in two ways. One, the real income I earn from dividends is reduced. This is because the amount I can buy for each £1 is now less since prices have risen fast. As a rule of thumb, I would like my dividend yields to be as high as the inflation rate. This ensures that at least I do not earn negative returns on my investments.
The second impact inflation could have on my investments is indirect. Runaway inflation can truly erode growth in a economy. This means that companies’ results can get impacted negatively, as they try to manage higher costs. A number of FTSE 100 companies have reported their discomfort with rising inflation recently and by the looks of it, it appears that could continue. Some might be able to pass on costs to end consumers for some time, but not all of them can do so. And even the ones who do so now, can probably not continue to do so sustainably. So, realistically speaking, I expect some impact to the potential capital gains from my investments.
How I’d select stocks to buy
In this scenario, I need to then choose FTSE 100 stocks that meet two criteria. One, their dividend yields need to be higher than 4%, which is expected to be the average inflation rate for the next years. And two, they should be in defensive sectors that are unlikely to be impacted significantly if inflation manages to drag profits or growth down, or both.
For me, the best stocks to buy then are utilities. All FTSE 100 utilities have higher than 4% dividend yields, except the water and wastewater services provider Severn Trent, which presently has a yield of 3.6%. United Utilities comes next, with a yield of 4.1%, followed by National Grid at 5%, and SSE at 5.2%.
Best utilities for me to buy
I have already bought SSE, partly for this reason. I like its dividend yield, and I also like that it is a renewable energy producer. At a time when polluting energy sources are in the process of being phased out, it is in a good place. The stock has fluctuated a lot in the past few years, but overall I like it.
National Grid is also a good stock in my view, and it even upped its earnings projections recently. It is a bit pricey, but I like it for its dividend continuity more than anything else. Next, United Utilities has done well at the stock markets in the past year and its yield is decent too, though it is third among my favourites because it has warned of inflation increasing its costs. Nevertheless, among all FTSE 100 constituents, it still does look attractive to me.
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Manika Premsingh owns shares of SSE. The Motley Fool UK has no position in any of the shares mentioned. 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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