3 Smart Stocks to Hedge Against Inflation

As far as inflation is concerned, the pandemic may have created the perfect storm. Since March 2020, U.S. lawmakers and the Federal Reserve have injected trillions of dollars into the economy, hoping to avoid a prolonged recession. At the same time, business closures led to bottlenecks in global supply chains, and labor shortages have made the problem worse. Collectively, these variables have created an environment that could drive prices higher across numerous industries.

In this Backstage Pass video, recorded on Oct. 20, Motley Fool contributors Trevor Jennewine, Rachel Warren, and Jason Hall highlight why MercadoLibre (MELI -1.01%), Pfizer (PFE 2.40%), and Trex (TREX -0.57%) look like smart investments given the current macroeconomic environment.

Jason Hall: In this case, let's talk about stocks that we like, that we think are inflation-proof. Trevor.

Trevor Jennewine: I'm going to go with MercadoLibre. I think any business that's making money by taking a percentage of payment volume that's moving through its platform is somewhat resistant to inflation, just because if prices of goods and services are going up then they are going to be taking a higher percentage of those goods and services. Just by the way, they monetize their business.

Hall: It's a tollbooth business with gigantic operating leverage.

Jennewine: Yep. I think on top of that, they also have a very strong competitive position. They're the largest e-commerce and digital payments platform in Latin America by multiple times. If you look at the traffic coming to MercadoLibre's marketplace, I think it's almost four times higher than the next-closest competitor, which I believe is Amazon.

If you're a merchant or a consumer in that region, where are you going to list your products? You're going to go to the place that has more traffic. If that's where merchants are going, then it's going to have a greater selection. And if it has a greater selection, that's where consumers are going to go, so you get that powerful flywheel that should help the company maintain that advantage in the coming years.

Then on top of that, they also have a whole ecosystem of these value-added services like logistics, fulfillment, financing. They provide digital advertising services that really just help merchants -- it's an end-to-end solution for commerce. They give merchants all the tools they need to start and then grow their business, including the payment processing platform, Mercado Pago. I think the company has all of that going for it. That's why I'd say the stock is somewhat inflation-resistant as far as tech stocks go.

Hall: There's also a decent chance that even if somebody is buying something off of the platform, it's still going through Mercado Pago. It's incredible. It's really just such an amazing business. I think you're probably right. Rachel if you're looking for inflation resistance, there's not better places to fish in than healthcare, right?

Warren: Right. I know this is why I love talking about healthcare stocks more than ever right now because I feel like this is an industry in particular that's just very resilient in a wide range of economic environments.

Obviously there's a lot of great companies I could pick but just off the top of my head, one of my favorite stocks that I think is very resistant to inflation is Pfizer.

I write about this company a lot. Obviously it's had this massive commercial success for the vaccine it developed with BioNTech for COVID-19, but it also has a really impressive product portfolio and a very strong product pipeline that spans so many different disease areas and faces really consistent consumer demand. These are the products that people rely on and need daily. In some cases, these are very much lifesaving medicines. Even just Pfizer's consumer healthcare products, one of the things I look for when I'm looking for companies that I think is going to be really robust in an inflationary environment, is looking for a company that either has significant pricing power and, or those products that people rely on and need on a year-round basis. I think Pfizer has advantages in both of those areas. Just as consumer healthcare products alone, you've got these things like Advil, ChapStick, Emergen-C. These are things that a lot of us carry with us or have our homes all the time. The company has really benefited from the vast commercial success of it's COVID vaccine, but I think it's using that as well to fuel its pipeline and growth in other areas.

Just a quick overview of its performance so far this year, in the first half of 2021, the company's revenues jumped 68%, and it's net income was up 53% from the same period in 2020. That is inclusive of its coronavirus vaccine. I think it just goes to show that even now with so many doses that have been distributed, there's still a very strong demand, particularly with all of these variants that are surging. Then the company's businesses across so many other areas from oncology to rare diseases, immunology are continuing to drive that strong growth. Pfizer also pays a dividend, which is really nice and has consistently raised that over time. I think this is a great company if you're looking for a stable investment that can add consistent long-term growth and value to your portfolio.

Hall: I think one of the most important competitive advantages to really understand when you're looking for companies that can resist inflation, have the ability to get through different economic environments, is cost advantage. You have pricing power on the what do you sell it for side, and you have cost advantage on the what is the cost for you to make it side.

A company that I love in this regard is a company called Trex. T-R-E-X. Trex manufactures this alternative wood decking -- 90% of the decks in the U.S., the linear feet of decking is wood, it's just regular would. You think about if I'm building a deck right now, lumber costs are crazy. They're very high. Now if I'm looking for wood alternative products like Trex. Trex manufactures the product. The majority of it is made out of scrap material. It's made out of recycled polyethylene film and scrap wood that comes out of lumber mills. It's basically saw dust. These are things that generally are going to end up in a landfill, unless a company like Trex sources those materials. And it gets these materials at a very low cost.

Over the past 10 or 12 years, the company has done an incredible job of improving their operating leverage by improving their manufacturing processes to increase throughput from their equipment. The input that's labor cost per linear foot that they make continues to fall. The quality of their product is very high. It's become the name: Trex is like Kleenex or Xerox or one of these brands or Zoom. It's the name that means the thing. Trex decking dominates. They have about half the market share in this. At the end of the day, the reason that they've become so dominant starts with that great products. By focusing on driving down their costs, they have a cost advantage. Now because they are the most dominant brand, they have pricing power. That pricing power is really valuable right now, with lumber costs continuing to go up.

I just want to share a quick chart right here. This is going to show, even as this market has become more and more competitive over the years, Trex, over the past decade, the purple line is gross margins and the yellow line is operating margins, the trend you can see is notably higher. In 2018 you see this period where margins have come down, operating margins have trended a little bit higher, but gross margins have come down because of an acquisition that was made into an industrial business. It's a little bit lower gross margins, but at the end of the day you see the larger trend is higher and higher. I'll tell you guys, it has really worked out on the bottom line. Earnings per share has absolutely skyrocketed. I'm going to drop that off just to show you. Investors have been rewarded with enormous total returns. I love the business. It starts with pricing power and cost advantage with a great product. That's Trex.