Inflation Insurance Stocks

By Sham Gad | November 29, 2010 AAA

While no equities can be assumed to provide pure protection against the ravages of inflation, there are certain characteristics to seek out when trying to combat inflationary effects on asset prices. While the threat of inflation seems a distant worry, investors are taking an expensive gamble by not thinking about inflation's consequences.

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The Worse Tax
With all the public concern about the expiration of the Bush-era tax cuts at the end of 2010, far less attention is being bestowed on the inflation tax. That is partly due to the fact that the inflationary tax is hidden - you don't actually see it creating an absolute decline in your savings like you do when stock prices decline or tax rates increase. Yet that is what makes high inflation all the more lethal - it's a real tax that hides from plain sight.

Inflation, defined as too much money, generally creates a rise in the price level of goods and services. Whether that rise is to do an absolute increase in price tags or a decline in the purchasing power of the dollar, the consequence is the same. So the easy answer to tackling inflation is to find companies that have pricing power during inflation. (For more, see Inflation: Introduction)

A Little More To It
Simple pricing power is not enough. What you really during periods of rising inflation are businesses that can increase prices without needing to experience an increase in demand. To that end, the Coca-Cola Company (NYSE:KO) stands out. Consumers are not likely to abandon their preference for Coke if the company decides to increase prices by a dime or a quarter. That's a incredibly valuable business moat. It's no surprise that Coke shares have done well in 2010, up 13% year to date. Shares do trade at a 52-week high of $64 and yield nearly 3%. Any pullback in share price may be a good opening to consider this best of blue chip stock.

Franchise type businesses like Deere (NYSE:DE) are also reliable bets. Deere not only sells you its tractors and lawn mowers, but it also services them through its network of service centers. That gives the company a recurring revenue stream to help offset unit sales. (For more, see 5 Agriculture Stocks To Grow With.)

Commodities can be good bets to make during inflation, if the underlying company has a low cost of production and does not have a significant amount of future capital expenditures on the horizon. Names like Korean steel giant Posco (NYSE:PKX) or natural gas company Contango Oil and Gas (NYSE:MCF) would be good candidates in this regard. Inflation increase the cost of PPE so if a business has some big cap ex projects coming along, that may be something to consider. (For more, see Turning Dimes Into Dollars.)

The Bottom Line
An ideal inflation-beating business is one that can sustain a return on equity that exceeds the inflation rate by a respectable margin. Few businesses have the moats to do that, but there are characteristics to look out for. (For more, see Coping With Inflation Risk.)

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