Investing in an inflationary market: The winners and losers

Inflation impacts different companies and sectors differently.

When deciding which companies to invest in and which ones to avoid in a high-inflationary environment, you could look for:

1. Companies with pricing power – an ability to raise their prices and not lose business
2. Companies with revenues that are tied to inflation – usually built into the contract
3. Companies that benefit from price increases of other companies, without the need to invest a lot of additional capital

1. Companies with pricing power

This category can include a few different types of products…

Companies that sell essential, non-discretionary products

For example, even in an inflationary market everyone still needs to buy food, household and personal care products, so grocery retailers and companies that produce and sell consumer staples like bread or toothpaste may be relatively better off compared to retailers that sell discretionary goods, nice to haves, for example toys, ice cream or jewellery.

People still need power for their homes, and petrol for their cars, so utilities and energy companies are usually less affected by inflation.

Companies with strong brand equity

When consumers know and love a brand, they are more likely to continue buying a product – even if the price goes up. For example, many Kiwis will suck up the impact of inflation on Whittaker’s chocolate and pay an extra 20 cents or so for a peanut butter slab, but they’ll switch to the store brand milk or tuna to save money on products with weaker brands that they don’t have strong brand love for.

Luxury goods

Funnily enough, true luxury goods companies (as opposed to affordable luxury companies) tend to do well during periods of high inflation too. While their products are not usually essential and are very discretionary, they do have strong brand equity and their products are highly coveted. They have pricing power because the target market for these products, for example Luis Vuitton, Ferrari, Chanel, etc. are high-income bracket consumers, and this group tend to be less affected by inflation than the low or middle income consumers – as they have more money to spend generally.

2. Companies with revenues tied to inflation

These are more defensive kinds of investments and include regulated utilities and real estate investment companies.

In New Zealand, Chorus and Vector are examples of regulated utilities – they have allowable revenue caps set by the Commerce Commission for a certain period, and beyond that period their earnings are determined by the value of their assets and by interest rates. As a result, they benefit from unexpectedly high inflation, which increases the value of their assets. Real Estate Investment Trusts (REITs) – can also benefit when their rental agreements include clauses that link rent increases to inflation.

3. Companies that benefit from price increases of other companies - without the need to invest a lot of additional capital

This category includes companies that benefit from the dollar value of transactions increasing, ie. when other businesses increase their prices, companies in this category also benefit. The best examples are companies like Visa and Mastercard. Their business model is to provide the infrastructure necessary to make payments and they receive a small fee from each transaction. They earn 20bps or 0.2% of the value of each transaction. As the cost of goods goes up, they ear more revenue. They already have the payment networks and infrastructure set up, so they don’t need to spend additional money to maintain these systems to accommodate the increase in expenditure going through these payment networks.

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