Wednesday, the US Federal Reserve announced its first interest rate hike since 2018 as part of its push to fight inflation, which currently runs at a four-decade high.
The widely expected move is the first of at least six rate hikes that the Fed signaled to implement this year. While monetary tightening seems unavoidable when price pressures are hurting many sectors of the economy, a hawkish central bank and the escalating war between Russia and Ukraine translate to heightened risks for equity investors.
In this current uncertain economic and geopolitical environment, investors should avoid low-quality stocks and focus on companies with resilient earnings, healthy cash flows, and the power to protect their margins amid higher input costs.
Keeping this theme in mind, below, we have short-listed three high-quality stocks which can benefit in a higher interest-rate environment.
1. Costco
If you’re seeking refuge in this unpredictable economic environment, shares of retailer-giant Costco Wholesale (NASDAQ:COST) are a good fit for you. The Issaquah, Washington-based company is a solid, long-term defensive play with its extensive store network and subscription-based retail model that provides stability to its revenue. It closed Thursday at $552.79.
Historically, large retail companies have been some of the best defensive stocks. Their wide economic moats, vast brick-and-mortar empires, and increasing dividend payouts have provided the safety net investors need during uncertain times.
In a recent note, Barclays said Costco is one of the greatest retailers in the industry ever, naming it “the GOAT” or “Greatest of All Time” thanks to its pricing and supply strategy.
The note adds:
“While COST never manages the business to a margin, we also believe COST has an ability to take more margin in today’s environment with strong traffic trends as well as price gaps to competitors.”
This financial strength has allowed Costco to reward shareholders with growing dividends. In November, the company announced a record $4.4 billion special distribution. Many analysts believe that Costco will become even stronger after the pandemic, delivering yet more upside for savvy investors. Costco provides a $3.16-a-share annual payout at a current yield of 0.58%.
2. Medtronic
Healthcare is one sector that tends to outperform when interest rates rise. In this group, we like Medtronic (NYSE:MDT) due to the company’s strong market position and its hefty payouts. MDT closed Thursday at $109.74.
The world’s largest medical device maker controls 50% of the global pacemaker market. It’s also a leader in products that assist with spinal surgeries and diabetes care.
Regardless of how the economy goes, stocks like Medtronic will continue to churn out cash. The Dublin, Ireland-based company has a long-term strategy to pay out 50% of its free cash flow to shareholders as dividends.
With a 2.39% annual yield, the company pays an annual dividend of $2.52 per share. That payout, on average, has increased more than 10% per year during the past five years.
The company is one of those solid, inflation-fighting stocks with a clear lead in the medical device business and the capability to rebound in the post-pandemic environment.
Bank of America, in a note this month, rated MDT as a buy, saying it’s a value name with the most upside potential as the elective surgeries gain pace after a couple of years of logjam due to the pandemic.
3. Cisco Systems
Cisco Systems (NASDAQ:CSCO) is another strong pick amid high economic uncertainty. The San Jose, California-based networking giant is the world’s largest producer of routers, switches, and other gear widely used to connect computers. It is a cash-rich company, well-positioned to pay uninterrupted dividends. It closed Thursday at $56.17.
Cisco has meaningfully improved its future growth prospects after an aggressive diversification drive away from hardware to a software-driven model within new, high-growth market areas, like cybersecurity, applications, and services. Revenue from subscriptions, for example, will reach 50% of the company’s total by fiscal 2025.
These growth initiatives, coupled with Cisco’s market leadership in the Americas, have placed the company in a privileged position for harvesting long-term profits.
Cisco is among the group of stocks that the global research firm Jefferies highlighted in a note yesterday, saying “cash machines” and quality plays like Cisco are some of the best performers in stagflationary periods.
The company currently pays $0.38 per quarter, which translates into an annual dividend yield of 2.65%.