With the generous liquidity central banks are providing, inflation has become a key concern. Unfortunately there has been scant clarity of inflationâs impact on stocks. Benjamin Graham has written an article about inflation simply titled âCommon Stocks and Inflationâ that sheds some light on the topic.
Graham explains his rationale for buying stocks, âThis is a good reasonâand there are othersânot to be enthusiastic about equities at every market level. This caution is part of my long-held investment philosophy. But what about the current situation? Should inflation prospects dissuade an investor from buying strong companies on a 15 percent earnings return? My answer would be âno.ââ
He makes clear the need to detach macro concerns if stocks are undervalued. He seemed to feel confident about prospects for stocks at the time he wrote this; I donât know if heâd feel the same way today.
Of interesting note, he does caution against investing in commodities: âThe first is that it is impossible for any really large sums of moneyâsay billions of dollarsâto be invested in such tangibles, [âreal estate, gold, commodities, valuable pictures and the likeâ] other than real property, without creating a huge advance in the price level, thus creating a typical speculative cycle ending in the inevitable crash.â
Graham doesnât define âstrongâ companies, but I imagine it wouldnât be too far off from Warren Buffettâs definition, and in âstrongâ he would include pricing power. The ability to pass on cost increases to consumers is critical for any business to survive in an inflationary market.
Oil refiners are currently in a precarious situation. Elevated oil prices mean their underlying costs have gone up. The price they receive is that of gasoline which they havenât raised as much as the underlying cost of oil. The Wall Street Journal described the situation in an article 1-2 months ago. Some U.S. refiners have considered the option of shutting down refining capacity if they arenât able to improve their margins. The Exxons and Chevrons, which have done well of late, are a more upstream operation. Exxon specializes in oil extraction and their profits are generally contingent on the price of oil.
Moving to a different industry, branded food products, Kraft has not blinked in their intent to raise prices. Higher food costs have squeezed their margins of late. The company is responding by reducing the amount of food in some products in addition to raising prices. Not surprisingly, very strong brands comprise the top of Warren Buffettâs holdings. Coca-Cola, Proctor and Gamble and Johnson and Johnson among others should be able to increase prices should inflation manifest itself.
The question then becomes: Are these stocks trading at prices that would yield 15% as Benjamin Graham specifies? My answer would be I donât know.
Disclosure: Long JNJ, BRK.B, KFT
Josh Zachariah
Graham explains his rationale for buying stocks, âThis is a good reasonâand there are othersânot to be enthusiastic about equities at every market level. This caution is part of my long-held investment philosophy. But what about the current situation? Should inflation prospects dissuade an investor from buying strong companies on a 15 percent earnings return? My answer would be âno.ââ
He makes clear the need to detach macro concerns if stocks are undervalued. He seemed to feel confident about prospects for stocks at the time he wrote this; I donât know if heâd feel the same way today.
Of interesting note, he does caution against investing in commodities: âThe first is that it is impossible for any really large sums of moneyâsay billions of dollarsâto be invested in such tangibles, [âreal estate, gold, commodities, valuable pictures and the likeâ] other than real property, without creating a huge advance in the price level, thus creating a typical speculative cycle ending in the inevitable crash.â
Graham doesnât define âstrongâ companies, but I imagine it wouldnât be too far off from Warren Buffettâs definition, and in âstrongâ he would include pricing power. The ability to pass on cost increases to consumers is critical for any business to survive in an inflationary market.
Oil refiners are currently in a precarious situation. Elevated oil prices mean their underlying costs have gone up. The price they receive is that of gasoline which they havenât raised as much as the underlying cost of oil. The Wall Street Journal described the situation in an article 1-2 months ago. Some U.S. refiners have considered the option of shutting down refining capacity if they arenât able to improve their margins. The Exxons and Chevrons, which have done well of late, are a more upstream operation. Exxon specializes in oil extraction and their profits are generally contingent on the price of oil.
Moving to a different industry, branded food products, Kraft has not blinked in their intent to raise prices. Higher food costs have squeezed their margins of late. The company is responding by reducing the amount of food in some products in addition to raising prices. Not surprisingly, very strong brands comprise the top of Warren Buffettâs holdings. Coca-Cola, Proctor and Gamble and Johnson and Johnson among others should be able to increase prices should inflation manifest itself.
The question then becomes: Are these stocks trading at prices that would yield 15% as Benjamin Graham specifies? My answer would be I donât know.
Disclosure: Long JNJ, BRK.B, KFT
Josh Zachariah
