How I am using income stocks to combat rising inflation

Inflation is rising, putting pressure on stock valuations across the globe. Here’s how I am using income stocks to protect my portfolio.

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Rising inflation is wreaking havoc with stock markets, leading to declining valuations and increased volatility. The FTSE 100 is down 6% year to date as a consequence, falling over 3% yesterday on news that the Bank of England was raising interest rates to 1.25%.

Portfolio protection

In the UK, inflation reached 7.8% year-on-year for April 2022. The May figure is expected to be released by the ONS on 22 June and is predicted to be even higher. As a consequence, the Bank of England has raised interest rates to 1.25% with the aim of slowing down price growth. This is putting serious pressure on stock valuations as people can now achieve higher risk-free returns.

In order to protect my portfolio from this rising inflation, I am looking to build up positions in income stocks: low-risk, high dividend-paying companies. These types of stocks are perfect for today’s market as they provide stability amongst market-wide volatility, whilst simultaneously outpacing inflation with high dividends. With inflation at 7.8%, I am hunting for good value stocks that pay a yield surpassing this figure.

In addition to high dividends, I am looking for stocks in ‘defensive’ industries. These are industries that tend to perform well in times of market volatility.

Companies in these industries tend to pay consistent dividends and generate stable earnings regardless of the overall stock market. Examples of defensive industries include telecommunication, as telecom firms often have large amounts of pre-existing infrastructure and large customer bases, meaning they can control prices in line with inflation.

An income stock I have my eye on

A high-yielding stock that I currently have my eye on is Rio Tinto (LSE: RIO). It is a multinational mining company, which specialises in base metals. The stock has performed well so far in 2022, up 12% year to date.

Rio Tinto currently offers a juicy 10.6% dividend yield, protecting me against the eroding value of money. In addition to this, the shares currently trade on a very cheap looking 5.1 price-to-earnings (P/E) ratio. This is strides below the widely accepted P/E ‘value’ barometer of 10. Comparing this to another global miner and close competitor, Glencore, I see value. Glencore currently trades on a P/E ratio of 16.

In addition to this, inflation usually benefits commodity producers, as it increases the value of commodities like gold and silver. Therefore, a Rio Tinto position could be a good inflation hedge for my portfolio. Also, the ongoing war in Ukraine has led to concerns over the supply of steel. Rio Tinto mines iron ore, which is a key component of steel. With the supply shortage further driving up iron prices, Rio Tinto is well positioned for more growth.

Therefore, I think Rio Tinto could be one of the best income stocks to add to my portfolio in the current macroeconomic climate. It has a high dividend, is low risk, and has a cheap valuation. I am therefore looking at buying shares for my portfolio soon.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Dylan Hood has no position in any of the shares mentioned. 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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