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Mohamed El-Erian Says Stagflation Is Coming; Here Are 2 ‘Strong Buy’ Dividend Stocks to Protect Your Portfolio

The ‘70s are coming back in a big way, and while that’s not so bad in fashion or in music, it’s safe to say that no one really wants that ‘70s economy back. That was the decade that brought stagflation, a nasty mix of high inflation, increasing unemployment, and stagnant job growth. Economists had long thought that combo impossible, but the economic mismanagement of the Carter Administration proved them wrong.

At least one top economist, Mohamed El-Erian from Allianz, sees a stagflationary period on the way, in the form of a global economic crash that few nations will escape unharmed. As El-Erian sees it, inflation is too high, and the Fed’s interest rate hikes to curb it are insufficient; the hikes are more likely to choke off growth while forcing a contraction of the labor force. The result: a near-term of rising prices, rising unemployment, and slow to nonexistent GDP growth, or in a word, stagflation.

“Lower US growth and a late #Fed forced to raise 75 basis points for a record third consecutive time are consistent with global stagflationary tendencies. Wouldn't surprise me to see further growth revisions,” El-Erian wrote.

It’s a situation that calls for defensive moves by investors, with an emphasis on ensuring an income stream that will provide some protection from inflation. In the world of equities, that’s a recipe for dividend stocks.

We’ve used the TipRanks platform to find a pair of dividend payers with Strong Buy ratings from the Street, and reliable dividends that have a history steady payments. And even better for defensive investors, both stocks have outperformed the overall markets this year, registering positive share gains where the broader markets have declined.

Merck & Co., Inc. (MRK)

We'll start with Merck, the well-known pharmaceutical company. This firm is one of the giants in the world of Big Pharma, with a market cap of $218 billion and more than $50 billion in annual revenues, of which some $22 billion came from the US market and $13 billion from the European markets. Merck aims to make itself the world’s leading research-oriented biopharma company and it boasts an extensive clinical trial program, with 83 programs undergoing Phase II studies and another 30 in Phase III.

Among Merck’s more recognizable products on the market today are Gardasil, and HPV vaccine used to protect women from cervical cancers, and Remicade, a biological antibody-based anti-inflammatory drug used in the treatment of autoimmune disorders like Crohn’s disease and rheumatoid arthritis. Historically, Merck was the creator of the MMR vaccine (measles, mumps, rubella) that has become standard for newborn infants.

The Big Pharma firms may have controversial reputations, but as Merck’s history shows, our medical system truly needs them. And Merck has ridden that need to solid financial results. In the company’s recent report for 2Q22, the top line came in at $14.6 billion, up 28% year-over-year. That number included 36% y/y growth in Gardasil sales, to $1.7 billion, and 26% y/y growth in sales of the anti-cancer drug Keytruda, which hit $5.3 billion. On earnings, the non-GAAP EPS rose 42% from the year-ago quarter, reaching $1.87 per share.

That last is an important metric, as earnings per share helps ensure the affordability of the dividend. Merck pays out 69 cents per common share – so EPS fully covers the payment – which annualizes to $2.76. At that rate, the dividend gives a yield of 3.2%. Merck has a 12-year history of both keeping up reliable payments and slowing increasing the dividend.

With this in mind, it’s no wonder that the company’s shares are up a 16% this year, far outperforming the overall markets.

All of that impressed Berenberg analyst Luisa Hector, who recently upgraded her stance on MRK shares and wrote of the company: “For investors seeking a low-risk value option in the pharma sector, we believe Merck & Co offers many attractions: medium-term growth just ahead of the sector average, limited patent expiry burden, low exposure to US price reform, margin expansion and no litigation overhang. Sales growth is highly dependent on Keytruda and Gardasil, but we think there are limited competitive threats…. We would endorse the return of Keytruda cash flows in the form of dividends and buyback. Merck & Co is our preferred value name in large pharma.”

Hector bumped her rating on this stock up from Neutral to Buy, and her $100 price target indicates her belief in a 15% one-year upside potential. (To watch Hector’s track record, click here)

It’s clear from the consensus rating, a Strong Buy based on 10 Buys and 3 Holds, that Wall Street generally agrees with the bullish views on this big-name biopharma firm. The shares are priced at $86.64 and their $100.75 average price target suggests an upside of ~16%. (See MRK stock forecast on TipRanks)

American Electric Power Company (AEP)

Let’s take a change of pace for the second stock, and shift from biopharma to public utilities. American Electric Power is one of the largest electricity providers in the US, more than 40,000 miles of transmission lines fed by over 26,000 megawatts of generating capacity – a number that includes some 7,100 megawatts worth of capacity from renewable sources, and 5.5 million customers across 11 states. AEP, with its large footprint in an absolutely essential economic niche, is a prime example of a defensive stock, and in fact, utility companies have long had a reputation for being ‘recession proof.’

A look at AEP’s financial results shows that the company has fared well so far this year, even as the first and second quarters both registered GDP declines. AEP saw $4.6 billion in revenue, with non-GAAP operating earnings of $617.7 million. While the top line was relatively flat y/y, earnings were up over 28%. Non-GAAP EPS came in at $1.20, just a shade higher than the year-ago result of $1.18.

In addition to sound results, AEP reiterated its guidance for the full year 2022, with non-GAAP earnings expected in the range of $4.87 to $5.07 per share. The company expects a 6% to 7% long-term growth rate going forward.

In one important metric of performance, AEP shares are up some 16% this year, dramatically outperforming the overall markets.

Once again, we’re looking at a company whose earnings fully cover the common share dividend. The last declaration set the payment at 78 cents per share, and was paid out on September 9. The current dividend annualizes to $3.12 and yields 3.1%. The true key to this dividend, however, is its extreme reliability. AEP boasts that it has paid out a cash dividend in every fiscal quarter since 1910, making this most recent payment the company’s 449th consecutive quarterly payment. There are very few public companies which can match that level of long-term dividend reliability.

Among 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 continue to hold its value on a relative basis and potentially outperform slightly in the event of a weakening economic backdrop or full recession given the utilities group tends to outperform after earnings peak and after a recession begins. Valuations have expanded but we don't see a clear case that the group is overpriced yet — valuations relative to the S&P 500, historical levels, and bonds are all below prior peaks over the last 10 years, so absent an economic uptick, we think the space is still reasonably valued for its defensive characteristics. In the event of a recession, we expect low risk names to outperform and prefer AEP,” Arcaro explained.

To this end, Arcaro rates AEP shares an Overweight (i.e. Buy), along with a price target of $118 to suggest a one-year gain of 18%. (To watch Arcaro’s track record, click here)

All in all, AEP has picked up 8 analyst reviews in recent weeks, and these include 6 Buys over 2 Holds, for a Strong Buy consensus rating from the Street. (See AEP stock forecast on TipRanks)

To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.

Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.
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