Inflation can be a scary word for investors, and many companies could indeed suffer if prices continue to increase. On the other hand, there are plenty of businesses that have the ability to pass cost increases along to their customers, and here are three in particular that look attractive after recent declines.
Excellent pricing power and incredible demand
A friend once told me that Disney (DIS 0.05%) could double the cost of its theme park admission and it wouldn't have a meaningful impact on attendance. And while I'm not sure the business could handle doubling the price, the fact is that Disney has tremendous pricing power. Its theme parks have never been making more money, and every time the company increases prices or starts charging for things that used to be free, customers simply absorb the cost.
To name an example, the Individual Lightning Lane system, which can cost upwards of $15 per ride, per person, replaced the free FastPass program, and regularly sells out. The cost of the ad-free Disney+ streaming service is set to rise by 38% in December, and most experts don't anticipate a significant decline in membership.
The point is that few businesses that sell discretionary products and services can pass inflationary costs through to consumers (and then some) quite like Disney can. And thanks to the market's pessimism on the streaming services path to profitability, as well as fears of a recession hurting consumer spending, the stock trades for more than 40% below its 52-week high.
This bank has a lot to gain from inflation
Bank of America (BAC 1.06%) stock has fallen by about 30% from the highs, and to be fair, there are some good reasons. There are fears that consumer spending could slow down, hurting loan demand. And recessions are usually accompanied by an uptick in loan defaults, which could result in large losses for banks if the economy worsens.
However, it's important to realize that banks also have quite a bit to gain from environments like this, and Bank of America is in an especially strong position. Specifically, Bank of America has a high proportion of deposits that don't pay interest, and the rates it charges on loans are moving higher as benchmark interest rates rise. Over the past year, Bank of America's net interest margin has already grown by 23%, and the bank estimates that a further 100-basis-point (one percentage point) increase in rates would produce an extra $4.2 billion in annual net interest income. And experts are expecting the Fed to raise rates by at least another 150 basis points before inflation is brought under control.
A red-hot industry with sticky customers
If I asked you what the hottest commercial real estate sector of 2021 was, you might guess something exciting like data centers or cell towers. But you'd be wrong. The best-performing real estate stocks of 2021 were self-storage, and while they have fallen in the recent market turbulence, there's still a lot to like about them going forward.
Life Storage (LSI) is an especially interesting company, whose stock has declined by more than 30% from the peak, despite excellent business results. In the second quarter, Life Storage's funds from operations – FFO, the real estate equivalent of "earnings" – increased by 38% year-over-year, a nearly unheard-of growth rate for a real estate investment trust. The main reason? Same-store revenue increased by 19% year-over-year, suggesting that consumer demand for storage has grown dramatically and customers are absorbing inflation and then some. With more people continuing to shift to remote work, the appeal of having uncluttered spaces is likely to grow for some time.
Life Storage also has a high-potential business model, and has been growing aggressively in recent years. The company's third-party management business is an especially interesting capital-light way to grow revenue over time. Plus, after a massive 46% dividend increase this year, Life Storage has a handsome 4.1% dividend yield as well, so you'll get a nice (and well-covered) income stream as well.
It isn't likely to happen overnight
To be sure, I feel that all three of these stocks have the potential to double within the next three to five years, not in the next few weeks or months. All three are well-run businesses with the ability to increase profits over time regardless of how high the inflation rate is. But there's likely to be significant volatility in the near term as the current economic uncertainty plays out.
