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Inflation Hits American Pocketbooks
Did you get a 7% raise last year?
If you didn’t, know this: your real earnings went down.
That’s the problem with inflation. It’s a quiet ghost that snuffs out the wages of the working and middle class. Cars… houses… groceries… everything suddenly becomes less affordable when consumer prices (CPI) are rising almost twice as fast as income.
Even the wealthy aren’t immune. High inflation in the 70s and 80s meant that the S&P 500 closed at the same inflation-adjusted level in 1990 as it did in 1969. Not all stocks, it turns out, are good inflation hedges.
Ordinarily, I use inflationary signals to time deep-value Moonshot picks. Many of my metals and mining recommendations have gone anywhere from 2x to 10x in the past year thanks to mild inflation.
But 7% is different. Unless you’re an emerging-market economy, that’s a level of inflation you don’t want to see. Millions of Americans are now locked out of buying houses or having the number of kids they want. Prices are rising across the entire developed world.
There is, however, some good news. Many investments do survive inflation. Deere (NYSE:DE), Honeywell (NASDAQ:HON) and other industrial companies did well during the 1970s thanks to their ability to pass cost increases to customers. And inflation, as we know, can be transitory.
Today, we’ll take a look at my three favorite “inflation-proof” stocks and see how they’re beating back the scary specter of rising prices.
The Three Companies Surviving Inflation
All inflation-resistant stocks have several common factors:
- High current profits. Inflation makes future profits less valuable. Inflation-resistant companies tend to have high profits today.
- Low debt. Rising interest rates (an inflation-taming tool) also make debts more expensive to service. Low-leverage firms tend to outperform high-leverage ones.
- Pricing power. Inflation-resistant companies need a “special sauce” to pass on high prices to customers.
- Cheap valuation. Deere was a good investment in the 1970s because its shares hovered in the 5-7x P/E range.
And there’s usually just one class of stock that meets all four criteria:
These names — from Timken (NYSE:TKR) to Borg Warner (NYSE:BWA) and yes, Deere and Honeywell — are typically boring companies producing high-value, low-cost products. If you’re selling a critical auto component for $15, safety-minded car manufacturers will sooner accept a one-dollar price increase than try to cut corners.
These stocks also tend to move slower than molasses in a New England winter. If you have the DNA of a defensive company, there’s little motivation to pursue risky growth.
Occasionally however, some Moonshots do fulfill these four criteria. And it’s these potential high-returners I’ll focus on today.
Arianne Phospate (DRRSF)
On Monday, I introduced Joanna Makris’ top pick of 2022. This high-grade phosphate producer made the top of her list thanks to its potential use in electric vehicle batteries:
“The high quality of Arianne’s phosphate is important for another reason. It can theoretically be used for applications outside of fertilizer. One of the most exciting areas of growth for Arianne is the use of its phosphate in both electric vehicle batteries and hydrogen fuel cells.”
— Joanna Makris, InvestorPlace.com
But there’s also an inflation-beating aspect of Arianne Phosphate (OTCMKTS:DRRSF) to love:
Its fixed cost basis.
Arianne sits on around 590 tons of high-quality phosphate, giving it an advantage in an industry where high-polluters can spend millions on post-cleanup costs. In other words, no matter how high prices get, the cost of pulling phosphate out of the ground won’t change drastically for Arianne Phosphate (developed oil rigs and high-yield gold mines also boast these advantages).
That’s essential for companies looking to beat inflation. If prices of a commodity are going up, they need to make sure costs (i.e., manpower, mining, land leases) don’t rise as well. Companies achieving that balance will soon find their way to greater profits.
Then there’s the second type of inflation-resistant company:
Firms that make essential products.
If you’re running a $5 billion chip foundry reliant on manufacturing perfection, there’s little incentive to try cutting corners. Saving $50,000 on a lower-quality inspection machine could cost you millions of dollars in defective semiconductors.
That’s the reason Camtek (NASDAQ:CAMT) makes my list of top inflation-resistant companies. The Israeli-based firm produces some of the highest-quality sensors to inspect wafers, chips and other micro-electronic devices. And because production values for Camtek’s customers are so high, they’re usually willing to pay CAMT a premium for its top-tier quality control devices.
The result: Camtek has developed incredible pricing power. The firm now generates $24 in net profit for every $100 of sales, making it not only stable but one of the highest-margin companies in the semiconductor industry.
There are certainly semiconductor firms with even higher margins. ASML Holdings (NASDAQ:ASML) — the top-tier maker of high-performance chip equipment — boasts margins a full 50% higher. But these top-tier companies also come with price tags to match. Investors looking for 2x… 5x… 10x gains need to go with companies at a slightly larger discount.
POSaBIT Systems (POSAF)
Finally, there are companies with a “special sauce” protecting them from inflation.
Which brings me to POSaBIT Systems (OTCMKTS:POSAF), a point-of-sale (POS) card company servicing the U.S. marijuana industry.
POSaBIT’s “special sauce” is straightforward: It’s one of the few financial firms marijuana dispensaries can actually use. Current federal regulations prohibit federally licensed banks from dealing in Schedule 1 drugs. So unless a dispensary works with POSaBIT, they’ll be forced to either 1) find a willing credit union or 2) conduct business entirely in cash.
The regulatory quagmire has benefitted POSaBIT immensely.
The POS firm has maintained its fee structure even as dispensaries push back against high prices elsewhere. Gross margins have remained in the upper-20% range, rather than falling with the rest of the marijuana industry.
Other “special sauce” companies are similarly thriving. Tech giants and bulge-bracket banks alike are reporting some of their greatest earnings ever. But finding one with Moonshot potential like POSaBIT is far more rare.
Beating Inflation with Winning Investments
You’ll notice none of these inflation-resistant companies I mentioned are unprofitable meme stocks.
That’s by design.
The last time the Federal Reserve raised rates faster than expected in 1999, it ultimately triggered the dot-com crash. Highly-valued startups with barely any revenue plummeted down to earth.
Today, I still believe some unprofitable companies have a way forward. Regular Moonshot readers will recognize names like GameStop (NYSE:GME), Armstrong Flooring (NYSE:AFI) and Volt Information Sciences (NYSEAMERICAN:VOLT) as companies with potential quality in the future.
But for those looking to also reduce inflation risk, it helps to make sure you’re buying quality today.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.