What Stocks To Buy If Inflation Rises

What Stocks To Buy If Inflation Rises? Inflation generally occurs so gradually that it is almost invisible from one day to the next. Every so often, you notice that prices seem a bit higher, but the cumulative effect isn’t obvious until you check your savings. A lifetime of financial responsibility means nothing if all the money you set aside has lost its buying power. 

Investment advisors usually recommend an asset mix that can keep up with inflation. Returns meet or exceed the rate at which buying power slips over time. However, a sharp rise in inflation due to an overheated economy can threaten to topple even the most carefully crafted portfolios. 

Some of the world’s most respected investors and analysts have warned that hyperinflation is coming – perhaps as soon as 2022. Measures in place to support economic recovery after the deadly COVID-19 pandemic may create conditions that push prices up at a rapid rate. 

Investors interested in protecting their portfolios against this scenario are asking what stocks to buy if inflation rises – and whether other assets could be a better choice to keep portfolio values stable.  

How Warren Buffett Thinks About Inflation

Warren Buffett has long been a voice of reason when the financial world gets overly excited or overly alarmed about general economic conditions or particular industries and companies.

He rarely buys into the hype around highly-anticipated IPOs, and when he is confident in a company he doesn’t sell – no matter how grim short-term results prove to be. 

Buffett chooses assets that will stand the test of time – strong companies with products and services that are in-demand. Then he holds long-term, barring any indication that recovery from a downturn may never come.

For example, Buffett is a fan of Coca-Cola, and he has held his shares for more than 30 years. On the other hand, in 2020, he divested airline stocks, understanding that it could be years before the travel industry returns to profitability. 

Buffett developed his strategy to protect against inflation in the late 1970s and early 1980s. His theory is best summed up by this classic Buffett quote: 

Be fearful when others are greedy and greedy when others are fearful. 

In other words, when share prices tumble, that’s the time to buy in – as long as the company is otherwise stable. When those same prices skyrocket on the heels of positive financial news, it’s best to avoid the likely overvalued shares. 

More importantly, when it comes to surviving periods of high inflation, the type of companies you invest in can make or break your overall returns.

Companies that need a lot of cash to operate are first to see profits decline, because inflation reduces their buying power. They must spend more on payroll, receivables, and inventory to keep sales volume consistent. Ultimately, that drives profits down. 

The Tapeworm Analogy

Warren Buffett’s take on the impact of inflation from a business perspective may be best understood with his tapeworm analogy.

In one letter to investors, he said this: 

Inflation acts as a gigantic corporate tapeworm. That tapeworm preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism.

Whatever the level of reported profits (even if nil), more dollars for receivables, inventory and fixed assets are continuously required by the business in order to merely match the unit volume of the previous year.

The less prosperous the enterprise, the greater the proportion of available sustenance claimed by the tapeworm… The tapeworm of inflation simply cleans the plate.

The inflationary tapeworm is less of a problem when you buy stock in companies that generate cash versus devouring it.

It’s worth noting that this is likely the exact reason Buffett sold his $4 billion stake in airlines that included American, Delta, Southwest, and United. In the second quarter of 2020, they reported daily cash burn rates of $59 million, $52 million, $17 million, and $40 million respectively. 

Instead of companies that must spend substantial amounts to generate sales, Buffett suggests companies that can increase prices without significantly impacting demand. Further, they should be able to manage increases in volume without investing a lot more cash into production. 

Tech companies may fit neatly into this space. Consider Netflix, which rarely loses customers when prices increase. Technology companies can often meet both criteria, as can financial services organizations. That explains why almost 75 percent of Buffett’s portfolio is made up of such stocks.

Investments to Make Your Portfolio Inflation-Proof

Outside of stocks, there are other asset classes that offer a hedge against inflation. Investment advisors often look towards commodities, real estate investment trusts, and gold stocks to protect portfolio value. 

Commodities

Commodity prices tend to match the pace of inflation, making them a classic choice for inflation-proofing portfolios. Examples include agricultural products, precious metals, and energy products. 

Of course, not every commodity is the right choice in every situation. The best investment may depend on what is driving inflation.

For example, if higher energy prices such as natural gas and oil are causing inflation, these are smart investments to protect against decreased buying power. 

Real Estate Investment Trusts

Real Estate Investment Trusts or REITs are more popular than ever, because they offer investors an opportunity to profit from the real estate market without the hassle of buying and selling individual properties.

The REIT operates something like an Exchange-Traded Fund (ETF) in that the trust owns and operates the income-producing real estate projects using capital provided by investor-purchased shares. 

REITs may choose a diverse mix of properties, such as office complexes, shopping centers, and residential buildings, or they may specialize in a specific type of real estate – for example, hotels, healthcare facilities, or farmland. 

Real estate tends to rise with inflation, though the trust’s focus will determine whether and how returns match the pace. 

Gold Stocks

Gold has always been a go-to investment when inflation threatens returns. Prices tend to move in the opposite direction of the overall market, so when stocks go down, gold prices go up.

Of course, few people have the interest and ability to buy and store the actual precious metal. Finding space and security to keep physical bars, bullion, and coins on-hand isn’t especially practical.

Instead, gold stocks can offer the same protection against inflation without the hassle of owning actual gold. These may include direct investment in shares of specific gold mining companies or purchase of gold-focused ETFs. 

Protecting Your Portfolio Against Inflation: The Bottom Line

The bottom line is that inflation risk is real, and investors who fail to protect their portfolios against lost buying power may find that their financial goals are ultimately unreachable.

Some stocks can survive periods of high inflation if they don’t have to spend a lot to increase sales volume.

Otherwise, many investors look at commodities, Real Estate Investment Trusts, and gold stocks to keep their portfolios intact. 

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.