After peaking above $5 per gallon in mid-June, the good news is gas prices are declining and nearing $4 per gallon. Commodity and food prices are coming down too. However, inflation is still near a 40-year high in 2022. The last time we had inflation like this, Ronald Reagan was the President.
As investors, we are concerned about inflation because it causes higher input costs for companies. In turn, greater expenses put downward pressure on margins making companies less profitable. As a result, less earnings growth or, even worse, lower earnings tends to impact stock prices negatively.
So what's an investor to do? It’s probably not possible to entirely inflation-proof your stock portfolio. However, you can fight inflation with a more diversified portfolio. Below we discuss some of the best stocks to buy for that purpose.
Inflation and the Stock Market
What is Inflation?
What is inflation? It is the increase in the prices of goods and services, reducing the buying power of the US dollar or any other currency. For example, when milk prices rise over time, the same $1 buys less. As a result, consumers lose buying power unless their incomes follow suit and increase as well. Moreover, inflation causes companies to lose purchasing power unless they can quickly increase the prices of the products and services they sell. To control inflation, interest rates are increased, and this typically causes growth to slow and unemployment to spike.
Inflation Lowers Stock Market Returns
Besides affecting the profitability of companies, inflation broadly affects the stock market. Most research suggests that high inflation causes low real returns for stocks. Real returns are nominal returns minus inflation. Additionally, inflation causes greater volatility, and the market’s ups and downs in 2022 seemingly confirm this point.
Value Stocks Usually Perform Better
Next, inflation tends to punish riskier assets. Riskier usually means growth stocks in the stock market, while value stocks are on the other end of the risk spectrum. For instance, many growth stocks rapidly increase revenue, but profits often follow much later because the companies invest in growing. Think of Amazon (AMZN) during its early years. The company was founded in 1994 but did not have its first profitable year until 2003. However, when inflation is high, interest rates tend to be higher too, and the cost of borrowing money to fund growth is high. Hence, growth stocks suffer, often entering a bear market.
On the other hand, value stocks usually have high cash flows and, in many cases, pricing power. As a result, they can raise prices to counter high input costs caused by inflation. Often, these stocks are defensive and pay growing dividends. Moreover, dividends are important because they help cushion the blow of lower stock prices. For example, if stock prices come down by 10%, a 3% dividend yield counters that decline. In addition, your passive income stream may not be affected. Companies try not to cut their dividend because it signals the company is performing poorly.
Keeping that in mind, here are three of the best stocks for you to own to fight inflation.
The Best Stocks to Buy to Fight Inflation
Coca-Cola
The Coca-Cola Company (KO) needs no introduction to most people. It has one of the most recognizable brand names in the world. The company is the world's largest non-alcoholic beverage company, with a presence in more than 200 countries. Coca-Cola's brands are powerhouses, with some generating more than $1 billion in yearly sales. Its leading brands are Coca-Cola, Diet Coke, Sprite, Schweppes, Dasani, Powerade, BodyArmor, Gold Peak, Fanta, Fresca, and Minute Maid. The company also owns many regional brands. Total sales were $41+ billion in the past twelve months.
Despite high inflation and increasing costs, Coca-Cola has shown its resilience. Sales grew 18% in the first quarter and 12% in the second quarter on higher volumes and prices. The company expects low-teens revenue growth and mid-teens earnings growth for the year. Investors are clearly impressed, and the stock price is up 6.3% year-to-date and 11.3% in the past year.
Besides good performance during a period of high inflation, Coca-Cola is a long-time dividend stock. It has paid one since 1920 and has increased it for more than 60 consecutive years. As income and dividend growth stocks go, Coca-Cola is a superstar. In addition, according to his 2021 letter, Warren Buffett owns about 9.2% of the shares.
The forward dividend yield is ~2.7% and is supported by a 70% dividend payout ratio and high cash flow.
The stock price is off its high, and the price-to-earnings ratio is down a bit to 25.6X. Still, investors may want to wait for a lower price and valuation before diving in and buying Coca-Cola.
- Ticker: KO
- Stock Price: $63.05
- Market Cap: $272.3 billion
- Dividend Yield (FWD): 2.73%
International Business Machines
The second stock on the list of best stocks for inflation is International Business Machines (IBM). Again, most investors know of the company, but it is one many do not like. IBM disappointed investors for about a decade and could not turn around declining revenue. However, the major RedHat acquisition, a new CEO, and divestment of Kyndryl have changed the story. As a result, IBM is growing and is seemingly relevant again. Total revenue was $59+ billion in the last twelve months.
The company is now positioning itself as a hybrid cloud and artificial intelligence (AI) player. The new IBM is primarily focusing on software and consulting. Additionally, it has a monopoly in mainframes and is a significant player in transaction processing. Each time you swipe your credit card, deposit a check at the bank, or make an airline reservation, it is probably an IBM mainframe and software processing the transaction.
IBM’s revenue and earnings are increasing during this time of high inflation. In Q1 2022, revenue was up 8%, and adjusted earnings per share rose 25% versus the prior year. In Q2 2022, revenue was up even more at 16%, and adjusted EPS grew an impressive 79% in comparable periods. The stock price is only down around 4.8% YTD and 4% in the trailing 1-year.
Investors will like IBM’s high dividend yield of nearly 5%. The company is another long-time dividend payer, starting its streak in 1916. IBM entered the list of Dividend Aristocrats a couple of years ago and now has a 27-year streak of increases. Although the yield is high, the dividend safety has improved with a 69% payout ratio and solid cash flow.
Investors should look at IBM for its dividend yield, reasonable P/E ratio of 14.1X, and improved outlook. Few blue chip stocks offer as high a dividend yield as IBM.
- Ticker: IBM
- Stock Price: $129.47
- Market Cap: $119.8 billion
- Dividend Yield (FWD): 4.90%
Chevron
Chevron Corporation (CVX) is another stock familiar to many investors. Most of us have filled up at one of the company’s gas stations. Chevron is involved in oil and gas exploration, production, and transportation. The company refines oil into gas, chemicals, and other products and sells them. Total revenue was more than $206 billion in the past twelve months.
It is one of the best stocks for investors to pick to fight inflation because gas prices typically surge during high inflation, like in 2022. Gas prices were more than $6 per gallon in west coast states and averaged more than $5 per gallon in the entire US. As a result, oil and gas majors like Chevron became immensely profitable.
Inflation is driving record top and bottom lines for Chevron. For example, in the second quarter, Chevron crushed estimates with revenue of $68.76 billion and the largest-ever quarterly earnings of $11.62 billion or $5.95 per share. In the first quarter, Chevron had $54.3 billion in revenue and earned $3.36 per share. Hence, investors are driving up the stock price, which is up approximately 30.3% YTD and 55% in the past year.
Chevron also pays an excellent dividend yield of around 3.6%. The dividend has been increased for 35 years, making the company a Dividend Aristocrat and Dividend Champion. Moreover, there is little risk of a dividend cut as record earnings have lowered the payout ratio to about 36% and increased cash flow.
Even after the run-up in stock price this year, Chevron is still trading at a reasonable valuation of ~8.1X. Gas prices may come down, but demand is rising, and Chevron should still be profitable and pay its dividend.
- Ticker: CVX
- Stock Price: $155.41
- Market Cap: $304.2 billion
- Dividend Yield (FWD): 3.55%
Final Thoughts on The Best Stocks to Buy to Fight Inflation
High inflation harms consumers, companies, economies, and stock markets. Costs are much higher, margins and profits are lower, and stock prices decline. However, growth stocks tend to perform worse than value and defensive stocks. In fact, some companies do better during times of high inflation. Investors seeking to avoid the effects of inflation on their portfolios must diversify their portfolios instead of focusing solely on riskier stocks. Stocks like Coca-Cola, IBM, and Chevron have performed relatively well during this time of high inflation and may be amongst the best ones to fight inflation.
Disclosure: Long KO and IBM
Disclaimer: The author is not a licensed or registered investment adviser or broker/dealer. He is not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.
This article originally appeared on Finance Quick Fix by Prakash Kolli.
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