Inflation and Impact on Stock Prices

Inflation and Impact on Stock Prices

On the weekend, investors/founders asked me my view on ๐ˆ๐ง๐Ÿ๐ฅ๐š๐ญ๐ข๐จ๐ง ๐š๐ง๐ ๐ข๐ญ๐ฌ ๐ข๐ฆ๐ฉ๐š๐œ๐ญ ๐จ๐ง ๐ฌ๐ญ๐จ๐œ๐ค ๐ฉ๐ซ๐ข๐œ๐ž๐ฌ.ย #inflationย continues to be the main topic when projecting the future of the economy and markets.

I shared my framework for picking the right stocks that act as anย #inflationhedgeย to invest in as Inflation impacts every value driver of valuation.

๐—ฉ๐—ฎ๐—น๐˜‚๐—ฒ ๐—ผ๐—ณ ๐—ฎ ๐—ฏ๐˜‚๐˜€๐—ถ๐—ป๐—ฒ๐˜€๐˜€ = ๐—ฅ๐—ฒ๐˜ƒ๐—ฒ๐—ป๐˜‚๐—ฒ๐˜€๐—ข๐—ฝ๐—ฒ๐—ฟ๐—ฎ๐˜๐—ถ๐—ป๐—ด ๐— ๐—ฎ๐—ฟ๐—ด๐—ถ๐—ป(๐Ÿญ-๐—ง๐—ฎ๐˜… ๐—ฟ๐—ฎ๐˜๐—ฒ)-๐—ฅ๐—ฒ๐—ถ๐—ป๐˜ƒ๐—ฒ๐˜€๐˜๐—บ๐—ฒ๐—ป๐˜ ๐—ฑ๐—ถ๐˜€๐—ฐ๐—ผ๐˜‚๐—ป๐˜๐—ฒ๐—ฑ ๐—ฎ๐˜ ๐˜๐—ต๐—ฒ ๐—ฐ๐—ผ๐˜€๐˜ ๐—ผ๐—ณ ๐—ฐ๐—ฎ๐—ฝ๐—ถ๐˜๐—ฎ๐—น (๐—ณ๐˜‚๐—ป๐—ฐ๐˜๐—ถ๐—ผ๐—ป ๐—ผ๐—ณ ๐—ฟ๐—ถ๐˜€๐—ธ-๐—ณ๐—ฟ๐—ฒ๐—ฒ ๐—ฟ๐—ฎ๐˜๐—ฒ, ๐—ฐ๐—ผ๐˜€๐˜ ๐—ผ๐—ณ ๐—ฑ๐—ฒ๐—ฏ๐˜, ๐—ฒ๐—พ๐˜‚๐—ถ๐˜๐˜† ๐—ฟ๐—ถ๐˜€๐—ธ ๐—ฝ๐—ฟ๐—ฒ๐—บ๐—ถ๐˜‚๐—บ, ๐—ฎ๐—ป๐—ฑ ๐—ฏ๐—ฒ๐˜๐—ฎ).

Inflation affects every value driver in the above equation as follows:

๐‘๐ž๐ฏ๐ž๐ง๐ฎ๐ž๐ฌ:ย Companies with higher pricing power can transfer higher prices to customers due to Inflation without any consequences. Thus firms with higher market share should perform well.

๐Œ๐š๐ซ๐ ๐ข๐ง๐ฌ: Companies with higher input costs (commodities/labour) operating in a highly competitive environment will witness a margin compression due to the inability to transfer high costs to customers.

๐‘๐ž๐ข๐ง๐ฏ๐ž๐ฌ๐ญ๐ฆ๐ž๐ง๐ญ:ย Companies with higher reinvestment needs may need to incur reinvestment at a higher price due to Inflation that can compress theirย #roic. Thus, capital-intensive firms that can defer their CAPEX should perform better than firms that cannot.

๐‘๐ข๐ฌ๐ค-๐Ÿ๐ซ๐ž๐ž ๐ซ๐š๐ญ๐ž: As central banks globally have increased interest rates, companies with higher D/E ratios should incur higher debt costs, reducing value.

๐„๐ช๐ฎ๐ข๐ญ๐ฒ ๐ซ๐ข๐ฌ๐ค ๐ฉ๐ซ๐ž๐ฆ๐ข๐ฎ๐ฆ:ย With higher Inflation, the investors will demand a higher return from investing in equities, increasing the equity risk premium, in turn reducing value.

๐๐ž๐ญ๐š:ย Firms with unproven business models and burning cash are riskier than mature firms with stable cash flows. Thus new-age start-ups that burn cash or distressed firms with a higher cost of debt have a higher risk of shutting down.

Thus, ๐ˆ๐ง๐Ÿ๐ฅ๐š๐ญ๐ข๐จ๐ง ๐ข๐ฆ๐ฉ๐š๐œ๐ญ๐ฌ ๐ž๐ฏ๐ž๐ซ๐ฒ ๐๐ซ๐ข๐ฏ๐ž๐ซ ๐จ๐Ÿ ๐ฏ๐š๐ฅ๐ฎ๐š๐ญ๐ข๐จ๐ง and investors looking to invest should focus on the following stocks:

๐’๐ฆ๐š๐ฅ๐ฅ-๐œ๐š๐ฉ companies with ๐ฅ๐จ๐ฐ๐ž๐ซ-๐๐ซ๐ข๐œ๐ž ๐ญ๐จ ๐๐จ๐จ๐ค ๐ซ๐š๐ญ๐ข๐จ๐ฌ, ๐ฅ๐จ๐ฐ๐ž๐ซ ๐๐ž๐›๐ญ ๐ญ๐จ ๐ž๐ช๐ฎ๐ข๐ญ๐ฒ ๐ซ๐š๐ญ๐ข๐จ๐ฌ and ๐ฌ๐ญ๐š๐›๐ฅ๐ž ๐จ๐ฉ๐ž๐ซ๐š๐ญ๐ข๐ง๐  ๐œ๐š๐ฌ๐ก ๐Ÿ๐ฅ๐จ๐ฐ๐ฌ should perform better than growth companies burning cash.

Thus, in my view, investing in boring matured companies like ๐„๐ง๐ž๐ซ๐ ๐ฒ, ๐”๐ญ๐ข๐ฅ๐ข๐ญ๐ข๐ž๐ฌ, ๐š๐ง๐ ๐œ๐จ๐ง๐ฌ๐ฎ๐ฆ๐ž๐ซ ๐ฌ๐ญ๐š๐ฉ๐ฅ๐ž๐ฌ ๐ญ๐ก๐š๐ญ ๐ฉ๐š๐ฒ ๐ฏ๐š๐ฌ๐ญ ๐๐ข๐ฏ๐ข๐๐ž๐ง๐๐ฌ ๐š๐ซ๐ž ๐›๐ž๐ญ๐ญ๐ž๐ซ ๐›๐ž๐ญ๐ฌย if higher Inflation continues.



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