Despite an unemployment rate barely higher than 4%, a situation that should induce wage and price growth, inflation has been chronically low for years. While it may seem as if this period of depressed inflation will never end, investors need to be prepared if inflation comes roaring back in the next few years.
We asked three of our Foolish investors to each put forth a stock that should do better than most during periods of rising inflation. Here's why they think JPMorgan Chase (JPM 1.28%), International Business Machines (IBM -0.05%), and Equity Residential (EQR 0.98%) are three potentially inflation-beating stocks.
Bank on this stock to tame inflation
Dan Caplinger (JPMorgan Chase): It's been a long time since investors had to deal with inflation, but even though it presents challenges, inflation doesn't have to be the bane of your stock investing. Some companies find ways to thrive in inflationary environments -- especially when upticks in prices aren't out of control. As one of the nation's largest financial institutions, JPMorgan Chase is poised to profit if inflation becomes a bigger concern.
Low inflation actually posed a conundrum for big banks such as JPMorgan. Savers had to accept little or no interest on deposits, making it harder for JPMorgan to woo deposit customers. Yet borrowers didn't want to pay high rates, and the combination crimped interest spreads and hurt a key source of income.
If inflation picks up, then JPMorgan investors can expect to see steeper yield curves, and that will make banks more profitable. If the longer-term interest rates at which JPMorgan lends money to customers grow faster than the short-term interest rates that the bank pays on its deposit accounts, then the result should be an increase in earnings. Although the stock's move higher reflects some expectation that this will happen, JPMorgan's status as a premier institution in banking gives it a leg up in taking advantage of the opportunity when it comes.
Value stocks for the win
Tim Green (International Business Machines): There's at least some evidence to suggest that value stocks tend to outperform the broader market during periods of high inflation. That may be because the underlying companies tend to be mature and stable, or simply because paying high prices for growth stocks is less appealing when inflation and interest rates are elevated.
With the S&P 500 valued at roughly 25 times trailing-12-month earnings, the current market isn't exactly a value investors' paradise. But there are still some decent value stocks that can help your portfolio hold up if inflation picks up. One good option is International Business Machines (IBM -0.05%). IBM recently reported its third-quarter results, and the stock surged as the company predicted a return to growth later this year. Even after this jump, IBM stock still likes like a good deal.
IBM expects to produce at least $13.80 in adjusted earnings this year, putting the PE ratio below 12. Not only can earnings grow in the coming years, but that multiple can expand if Big Blue can maintain the revenue growth it expects to report for the fourth quarter. Another benefit: Around two-thirds of IBM's revenue comes from overseas. The company will enjoy a tailwind if the U.S. dollar weakens, boosting its top and bottom lines.
The path of inflation is unpredictable. But buying a value stock like IBM could provide some protection if this current period of low inflation comes to an end.
A real estate inflation hedge
Travis Hoium (Equity Residential): Owning real estate, or REITs, is one way to hedge against inflation and apartments are some of the most stable real estate investments on the market. People need places to live, particularly in prime markets such as Manhattan, Boston, Washington, D.C., San Francisco, Los Angeles, and Seattle, providing consistent cash flows to the company. And that's where Equity Residential has most of its properties.
The reason real estate is a hedge against inflation is that real estate values generally rise as the dollar falls. For a REIT owning apartments, that can mean higher rents or rising values of the underlying real estate the company owns.
The one risk to watch with inflation is interest rates. Rising rates can increase borrowing costs for REITs, and over-leveraged companies can be a huge risk if companies can't absorb the higher cost. Equity Residential's $9 billion in debt on $25.5 billion in real estate assets ($19.8 billion after depreciation) is very conservative for an apartment REIT.
Equity Residential's 3% dividend yield isn't the highest you'll find in the REIT market, but the stability of apartment buildings and the hedge against inflation makes this a great play for investors today.