How does inflation benefit company profits and share prices?
Equities tend to be a great beneficiary of inflation because company sales and profits tend to grow with inflation – and often by much more.
For many companies it’s even better because they have operational leverage where costs are fixed whilst sales can rise with inflation, resulting in a turbo-charging of profits. This goes a long way to explain why stock-markets keep appreciating over time.
Simple illustration …
Using a simple example, let’s say a company had £100k in sales and £80k in costs. That results in profits of £20k. Now, let’s assume 5% inflation across the board. As a result revenues rise to £105k and costs go up to £84k – resulting in a profit of £21k. That’s a 5% increase in profits (£21k vs £20k).
In reality it’s much better because of operational leverage as many company costs are generally fixed in the short-medium term – eg rents, staff, leases, contracts. So in reality, companies can enjoy an inflation-beating rise in profits.
So using operational leverage in the above simple example, sales go up by 5% to £105k but costs may only go up by 2% to £82k. As such, profits increase to £23k. That’s a 15% increase in profits due to operational leverage.
Hence stocks go up …
All else being equal, as profits rise, share prices also appreciate. Hence, equities tend to be a great hedge for inflation!
How to take advantage?
There are many globally diversified equity ETFs out there. Vanguard, iShares and SPDR are effective providers of global equity ETFs.
In our Investment Academy programme we provide you with a model list of the best and low-cost ETFs and funds that can be set-and-forget to benefit from long term inflation-beating compounded growth.
Key Messages from this article …
- Inflation is painful as a consumer but beneficial for the investor
- Equities are a great hedge against inflation and the cost of living
- Stocks are a proven way to beat inflation
- Companies benefit by increasing prices and profits
- This is a long-term phenomenon
- Take advantage by investing in a properly diversified, set-and-forget ETFs and funds
- Time in the Markets always beats timing the markets
- Stay Diversified
- Think Long-term
- Minimise those leakages
- Stay educated to outperform 99% of the population
Ps: Hundreds of people have learnt how to pound-cost-average into low-cost, diversified set-and-forget ETFs & Funds for inflation-beating growth. And Options for recurring income.
Click here to learn about our Investment Academy,
– Don’t take the above as advice as it may not apply to you personally
– Your Capital is at Risk
– You may not be covered by the FSCS
– Anything mentioned in a podcast or in a previous article was valid at that time and may not continue to be now