Inflation is insidious, slowly eating away at the value of your money. Although the rate of inflation is elevated today, bringing the issue to the fore, it is almost always working in the background.
Indeed, inflation is something you should be thinking about at all times when you invest. Which is why you might want to include dividend growth stocks like A. O. Smith (AOS 0.47%) and Fastenal (FAST 0.04%) in your portfolio.
The pain you feel but don't see
The historical growth rate of inflation is around 3.2% annually, so low that it can be hard to tell that anything is changing from year to year. Over the past 18 months or so, however, inflation kicked up dramatically for a time as companies try to pass on rising costs to end customers.
The price increases are clearly present in the grocery store, as you buy materially less food with the same dollars. Many consumer-staples makers have pushed through multiple rounds of price hikes in a very short period of time when, historically, they might have only increased them once a year.
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But don't get too caught up in today's inflation rate. In fact, the latest monthly report suggests it is effectively back at historically normal levels and well down from the 9.1% levels seen last summer. The real lesson here is that inflation destroys the buying power of your dollars, and it is a problem you need to address.
One way to combat the ravages of inflation is to buy dividend growth stocks -- particularly stocks with long histories of fairly rapid rates of annual payout increases. In this way, you might not only offset inflation, but you might also even outpace it and boost the buying power of the income you collect from your portfolio. Here's a bit more about the two dividend stocks mentioned above.
1. A.O. Smith: Giving the world what it wants
Industrial company A. O. Smith makes water heaters. Hot water is an affordable luxury that everyone wants and few are willing to give up once they have it. The core of the business (roughly 75% of revenue) is North America, where replacement sales provide a solid base for the business as a whole. A slow and steady increase is the expectation here.
The rest of the business is described as "rest of world," but it is basically Asia. China has been the big growth story for many years, with the company now focused on using its China playbook in India. Both countries are filled with people stepping up the socioeconomic ladder. That means finally getting access to hot water.
So the big picture here is a solid foundation (North America) supporting growth-focused expansion in newer markets (Asia). But the real story for investors worried about inflation is A. O. Smith's three-decade history of annual dividend increases. Over the past decade, the dividend has risen at a very rapid 19% annual rate.
To be fair, A. O. Smith has been having some issues in China, so the business isn't hitting on all cylinders today. But despite that, the last dividend increase was still 7%.
If that's what this dividend growth stock can do in a bad year, long-term investors should be very happy. The yield is around 1.6%. That is a modest yield. But added to a portfolio of higher-yielding stocks, it can help fight the ravages of inflation.
2. Fastenal: A team player
Fastenal is an industrial parts and tools provider. It looks to partner with its customers, integrating itself into their supply chains so that it is hard to bring in a new supplier.
In recent years, it has been shifting from owning stores to physically embedding itself into customer locations with things like vending machines and direct supply routes. Selling nuts and bolts is pretty simple, but Fastenal has turned it into something of an art form.
The company's business is cyclical, so investors have to understand that performance (and the stock price) will wax and wane along with the economy. But if you are patient and can think in the long term, an economic downturn could be a great time to add the stock to your portfolio.
The biggest reason is that it has grown its dividend for 24 consecutive years with a rate of 14% over the past decade. The most recent increase was a huge 13% or so.
While you should expect smaller increases during recessions, the long-term trend here is very clearly rapid dividend growth. As with A. O. Smith, adding this stock to a dividend portfolio can definitely help to offset the hit of inflation. The yield is currently around 2.4%.
Fast and steady
Inflation is always with us, so you always need to think about it. For dividend investors, that means including at least a few dividend growth stocks like A. O. Smith and Fastenal in a portfolio. If you do that, inflation shouldn't be as insidious a headwind.
