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Can Your Stocks Defeat the Inflation Demon?

“Americans are getting stronger. Twenty years ago, it took two people to carry ten dollars’ worth of groceries. Today, a five year old can do it.” – Henny Youngman

This is a telling statement on the menace that is inflation.

You must’ve heard stories from your grandmother how a few rupees used to buy a week of groceries when she was young.

We, the present generation, can only imagine such a situation. Now a few rupees would get you a snare from a beggar!

Anyways, inflation is now so much part of our daily life, that we sometimes do not feel its impact – at least not till it brings us tears in the form of rising onion prices.

Apart from hurting us as consumers, inflation also plays a big part in our investment planning.

After all, if inflation was non-existent, i.e., prices of everything remained constant throughout, we would never have had the need to grow our money at 15-20% by investing in stock markets.

Earning fixed 5-6% in interest by investing in bonds, fixed deposits, or even keeping money as bank deposits would have been good enough.

But that’s not the case. Inflation hangs above us like the sword of Damocles.

And it’s important that you as an investor know what kind of returns you must earn on your stocks to beat rising prices over the long run.

Can stocks save you against the inflation demon?
Well, that’s what has been the belief all these years.

“Buy stocks to beat inflation,” has been the common advice to stock market investors.

But just like any stock market advice, this is not entirely true.

One of the key ways inflation hurts stock market investors is by way of hurting the profits of companies.

Companies need to buy raw materials and hire employees to run their operations. The cost of raw materials and wages of employees rise in an inflationary environment.

If a company can pass on such a rise in costs to customers in the form of higher prices of products and services, it can improve its profits.

But if it can’t raise prices even when its raw material costs and employee wages are rising, its profits will be hurt. And so will be the return for investors in its stock.

Thus, stocks of companies that have the power to raise prices in inflationary times are good investment options for investors.

But again, that’s just a rational view and not always the reality. Even such companies, after a certain level, may not find it easy to raise their prices thereby taking a hit on their profits.

The real goal of investing
For some people, the real goal of investing is not so much getting ahead as it is not falling behind.

Because inflation marches forward year after year, the fear is that your buying power will weaken if your investments do not appreciate as quickly as the cost of what you buy.

Most of our savings are eaten up by inflation. This is especially true of savings held as bank deposits and bonds.

Thus it is important for you as an investor to carry some insurance against inflation. There is no certainty that stocks will ensure you adequately against this demon.

In fact, stocks in general, like bonds, do poorly in an inflationary environment.

But stocks of companies that have the pricing power to raise their prices in an inflationary environment, they carry more protection than bank deposits and bonds over the long term.

The reason is simple: Stocks of such companies are claims on real assets, such as land and plant and equipment, which appreciate in value as overall prices increase.

As Warren Buffett says, “Stocks are probably still the best of all the poor alternatives in an era of inflation – at least they are if you buy in at appropriate prices.”

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.