Inflation may be slowing down, but it still remains near a 40-year high and is the primary reason the stock market's performance last year was its worst since 2008.
High inflation led the Federal Reserve to ramp up interest rates, causing stocks to fall as investors moved money to higher-yielding bonds and prepared for a possible recession this year.
At uncertain times like these, it's a good time to consult the wisdom of great investors like Warren Buffett, who was active in the market the last time inflation was this high, in the early 1980s. Back then, in his 1982 letter to shareholders, Buffett noted that businesses that outperform in inflationary environments have two qualities.
First, they have pricing power, or an ability to raise prices without significant loss of market share or unit volume, as Buffett put it. Second, they should have the ability to expand capacity without the need for a significant increase in capital expenditures, thereby benefiting from higher prices without needing to increase costs.
At the time, Buffett noted that very few businesses possess both qualities. However, there are two companies that didn't exist back then that embody both of those characteristics now.
Image source: The Motley Fool.
1. Airbnb: a dominant travel marketplace
Airbnb (ABNB 2.77%) has established itself as a fast-growing disruptor in the travel sector, pioneering the home-sharing concept.
Not only has the company carved out a unique niche in the massive travel industry, but it also benefits from a business model that generates wide profit margins on relatively small capital expenditures, meeting both of Buffett's inflation criteria.
As an e-commerce marketplace, Airbnb makes money by charging hosts and guests a service fee based on bookings. Primarily, it makes money from a service fee of up to 14.2% on guests, though it also charges hosts a 3% fee, generally to cover credit card processing fees.
Airbnb has historically grown its business by attracting more hosts and guests to its platform, but the company also has pricing power to raise its take rates if it sees fit. Many of its hosts rely on it for a significant portion of their income, and guests often turn to Airbnb because it's cheaper than hotels or offers amenities, like a kitchen, that hotels don't.
As prices rise with inflation, Airbnb should benefit regardless of its take rate if prices for accommodations on its platform rise.
Because of its marketplace model, Airbnb also has the ability to expand its capacity without spending much. In fact, its capital expenditures were minimal through the first three quarters of 2022 -- at just $16.6 million even though the business grew rapidly.
That combination of features makes Airbnb well-positioned to gain market share in 2023, especially if inflation remains elevated.
2. Alphabet: a digital ad powerhouse
Alphabet (GOOG 1.25%) (GOOGL 1.27%) has long had a near monopoly in internet search, with a market share above 90% in most of the world.
Pricing for its core product, Google Search, is generally determined by auction, but the huge profits that the company has historically generated show how that business and related ones like YouTube enjoy significant pricing power.
Since Google has a dominant market share in search, advertisers need to be on the platform if searchers are looking for deals on Google. Industries like insurance, travel, and retail have traditionally been major advertising verticals for search, and that's unlikely to change regardless of the prices advertisers need to pay as long as they're generating a positive return on investment.
Even if Alphabet were to raise its advertising prices, there's little risk of those advertisers fleeing to an alternative like Bing since no other search platform comes close to the traffic of Google. Additionally, as the prices for goods that advertisers are selling rise, they naturally have more money to spend on advertising.
Similarly, Alphabet's ad business requires little capital investment to scale. In fact, Google Search is noteworthy for how little the interface has changed since its early history.
Alphabet has spent aggressively on capital expenditures, but that is primarily to fund growth in its cloud business and other bets like Waymo, its self-driving car project. The success of its ad business has allowed it to spend on those other businesses, and the nature of its digital ad platform makes it highly scalable as it doesn't require the kind of human resources that advertising traditionally did.
While Alphabet is sensitive to the business cycle and consumer spending, its advertising business, with its huge market share, can withstand any inflationary pressure in 2023 and should benefit from higher prices over the long term.
Though Warren Buffett's Berkshire Hathway doesn't own either of these stocks, they seem like they would fit well in his portfolio, especially as both look cheap after falling sharply last year.
