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What are the best stocks to watch when inflation is high?

With inflation concerns on the rise, let’s look at the effects it could have on industries; who will outperform, who will underperform, and which stocks to watch if we do see an inflationary 2022.

This article was originally written by MyWallSt. Read more insights from the MyWallSt team here.

 

Historic industry and stock performance

The best-performing stocks in inflationary environments have proved to be energy, financials, precious metals, property real estate investment trusts (REITs), and consumer staples. Other than precious metals, many of these industries would be deemed the most essential services for consumers and they aren’t inventory-heavy sectors.

On the underperformance side of things are communications, IT, mortgage providers, and consumer discretionary businesses. Companies that are labor-intensive, or outside the realm of “must-haves” for consumers and businesses usually struggle, along with those that are tied to high price-earnings (P/E) multiples, which leads me to growth stocks.

Growth stocks generally suffer in inflationary environments for a number of reasons. With higher inflation expectations, projected discounted cash-flows are often hurt, which consequently drags down P/E ratios and valuations. Many smaller growth companies also rely on access to capital to expand, and credit can be more difficult or expensive to attain.

This doesn’t mean all growth stocks will be pummelled in an inflationary environment, but it can be a good idea to be more particular about stock picks. Service companies with lower labor costs, enough cash to fund investment, and access to revolving credit facilities can be things to watch out for, and the more essential its service is, the better.

The revolving credit facility is an important one to note — this means the borrower can get additional credit, or repay loans if rates are fluctuating. Inflation can bring with it higher interest rates, and companies can handle exposure more efficiently.

 

Two stocks to watch

Google

Tech as a whole may not be the best option, but Google (NASDAQ: GOOG) has one of the most resilient business models in the market. While ad spending could decline in the short-term in an inflationary environment, users will still use its platforms out of necessity for its search and enterprise segments, and for free entertainment from its YouTube platform.

The company has a reasonable P/E ratio of 28 and is well-capitalized too, with $136 billion in cash, cash equivalents, and marketable securities in its most recent quarter. 


Berkshire Hathaway

Berkshire Hathaway (NYSE: BRK.B) is managed by the most prominent investor duo of all time, Warren Buffett and Charlie Munger. With more than a century of combined experience in the markets, the pair have navigated almost any macroeconomic trend imaginable, so a situation like this should be business as usual for them.

Berkshire as a holding company owns a diversified portfolio of investments across industries, but portfolio concentration is geared towards banking and insurance, and as discussed, the financial sector usually performs quite well in this environment.

Berkshire also has a fortress of a balance sheet to navigate any downturn, with a cash pile of over $149 billion, which also presents the opportunity to purchase shares in businesses at discounted valuations, if the opportunity arose. 

 

Takeaway

Inflation isn’t necessarily a bad thing, in fact, it can be a sign of a healthy economy. The real concern generally applies when it gets way out of hand, to the point where there are different prices being charged on a weekly basis — take Argentina as an example, where inflation is over 40% — it means companies operating there pose a higher risk.

Once contained, however, inflation is manageable, so there’s no need to spin out of control if you’re working off a long-term investment thesis.

 

MyWallSt gives you access to over 100 stock picks and the research to back them up. Our analyst team posts daily insights, subscriber-only podcasts, and the headlines that move the market. Start your free trial now!

Disclaimer Past performance is not a reliable indicator of future results.

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.

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