Interest rate hikes tend to negatively affect stocks in general. This is because stocks are typically seen as higher risk compared to other investments such as bonds or GICs.
When the interest rate increases, some investors rotate out of stocks and into interest-producing investments that have lower risk.
The interest rate reported by the Bank of Canada has been in a downtrend for the past 25 years. During that time, it hit a high of 16% in 1991 and a low of 0.25% in 2009.
With a potential rate hike from the Fed soon, Canadian investors may be fearing that Canada will follow soon after, especially since the interest rate is at the low end of historical levels.
Which dividend stocks are best for countering interest rate hikes?
Cheap dividend stocks
Businesses that are priced at a discount already have a margin of safety. However, we’re assuming that the following businesses are temporarily mispriced and that they will trade at normal historical levels again in the future.
For example, Dream Office Real Estate Investment Trst (TSX:D.UN) is priced at $20 per unit with a yield of 11.2%. Further, its book value is $33.6, so it is discounted by 40.5%.
Thus, the REIT is an income play with the potential for price appreciation. REITs own real estate properties that should hold up in value and have a strong ability to generate income in the form of rent.
High dividend-growth stocks
High-growth stocks are companies that grow earnings or cash flows at a rate of over 10% per year on a per-share basis. That growth allows these businesses to grow dividends at a high rate as well. So, the businesses in this category should also have a track record of growing dividends.
The idea is that these stocks grow at a much higher rate than interest rate hikes.
Although Enbridge Inc.’s (TSX:ENB)(NYSE:ENB) stock price hasn’t done so well lately, it generated more than enough operating cash flow to cover dividends with leftovers in the third quarter of 2015. The business reaffirms its forecast of 14-16% annual dividend per-share growth through 2019.
In my opinion, Enbridge is a high-growth opportunity that’s also priced cheaply after the price decline due to lower commodity prices. According to its normal multiple, its fair price should be around $63. So, it’s discounted by about 20% compared with historical levels.
In conclusion
Investors should look for discounted dividend stocks such as Dream Office or high-growth dividend stocks such as Enbridge to counter any interest rate hikes that might come. Whether the rates are hiked or remain constant, you can enjoy the dividends that roll in.
