Despite inflation starting to decline, interest rates have continued to rise, albeit at a slower pace than previously in the year. It creates a precarious situation, especially for income investors, because many dividend stocks rely on debt to elevate returns. As variable interest costs rise, they can eat into profits and eventually leave nothing for the dividend.
We have already seen rising interest rates force once “safe” companies (like Algonquin Power) to lower their dividends. This also tends to have a very negative consequence on the stock price. Even the perception of a dividend being cut can lead to a drastic stock price decline (like Northwest Healthcare REIT).
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Worried about interest rates? Buy debt-free stocks
If you are worried about interest rates continuing to rise, there are a few things you should do. Firstly, own a wide array of Canadian stocks that include income, growth, and value. Likewise, diversify by sector, so you are not caught if a certain sector is temporarily affected by macro-economic concerns.
If you want to entirely avoid interest rate risk, just buy stocks that don’t have any debt. No debt means companies don’t have to worry about the rising cost of financed capital. No debt means it would be very difficult for a business to go broke or bankrupt.
Two examples of debt-free growth stocks are Hammond Power Solutions (TSX:HPS.A) and Calian Group (TSX:CGY).
Hammond Power Systems stock
Hammond sells a large portfolio of power and electrification solutions for manufacturers, utilities, data centres, and even car charging. Over the past few years, the company has rapidly been diversifying and expanding its product offerings. As a result, its end markets are broader. Its sales should prove fairly resilient, even in a recession.
Over the past three years, it has grown earnings per share by over 200%. In that time, its stock has risen 650%! Despite its explosive returns, this stock still only trades for a modest 10 times earnings. Insiders continue to own a large stake in the business, so that should signal that there is alignment with long-term shareholders.
The company has net cash of around $15 million on its balance sheet. That should provide plenty of firepower for acquisitions and potential organic growth in the years ahead. This stock also happens to pay a 1% dividend that has been growing at an attractive rate.
Calian Group
Calian Group is another under-the-radar, cash-rich stock. Calian has about $35 million of net cash on its balance sheet. While this stock is down around 8% this year, it has had a good 85% run up over the past five years. Not to forget that it also pays a decent 1.8% dividend yield.
Calian operates a mix of businesses in healthcare, training, advanced technologies, and IT/cybersecurity. Its management team calls this “the four-piston growth engine.” These segments help provide diversity, but there is also a meaningful opportunity for organic growth and cross-selling between the businesses.
Calian has grown normalized earnings per share by around 17% per annum for the past three years. It has come at this through a combination of smart acquisitions and organic investments. This year, it announced a strategically significant acquisition of a teleport and network provider in Hawaii.
That deal should provide a nice source of recurring revenues and income in late 2023 and 2024. At less than 15 times earnings, this stock looks like a good bargain today if you have a longer investment horizon.
