In the past couple years, there's no doubt that inflation has been a major topic of discussion. Rising prices across the economy were never really an issue for most of the past decade. That is, until inflation reared its ugly head even as the economy started to recover from the massive disruptions early in the pandemic.
To be fair, the Consumer Price Index is showing signs of cooling down. But that doesn't mean that people can completely ignore this topic. Inflation still remains well above the Federal Reserve's 2% target.
As a high-level macroeconomic factor, investors have zero control over what happens with inflation. However, what's encouraging is that we still have the ability to control what we do about it. Let's take a closer look.
Inflation overview
It's important to understand what exactly inflation is. It's best to look at this from two angles. On the one hand, supply-side constraints, like the global semiconductor chip shortage, as well as supply-chain bottlenecks, can lead to higher prices for consumers for affected products.
Also, inflation can be caused by stronger demand from consumers chasing the same or fewer quantity of products. This can happen when the government makes huge stimulative efforts, like what was done to help get the economy past the worst of the pandemic.
As I noted above, the central bank deliberately targets an annual inflation rate of 2%. Fed officials believe this is the sign of a healthy economy. The thinking also goes that a certain level of inflation encourages consumers to spend, which is the most significant driver of economic growth.
Think about what would happen if instead of inflation, prices for goods and services actually dropped each year. In this scenario, consumers would be more inclined to just wait to buy things because they know that everything will be cheaper in the future. This is what the Fed wants to avoid.
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How to position your portfolio
It's anyone's guess what inflation trends will look like going forward. But the smartest investors can adjust their strategies to do well regardless of what happens.
With that being said, I believe that it's a good idea to identify businesses that have pricing power. This way, they can offset -- and even outpace -- rising inflation by asking their customers to pay more for what they offer.
Chipotle Mexican Grill is an excellent example. In its latest quarter (Q3 2023 ended Sept. 30), the Tex-Mex chain reported adjusted diluted earnings per share of $11.36, which exceeded Wall Street's expectations. Management said the strong results were due to menu price increases. Despite this, customer traffic was up. In the past few years, Chipotle has raised prices numerous times, yet sales and earnings have soared.
In the media and entertainment sector, Netflix has proven pricing power. In the last decade, the streaming pioneer has consistently raised its subscription prices, especially in the U.S. More recently, the leadership team announced a price hike to two of its plans. This was on the heels of a blowout quarter. Netflix reported adding 8.8 million net new members in Q3, which was well ahead of consensus estimates.
Two companies that are uniquely positioned to combat inflation are Visa and Mastercard. The payments facilitators make money by charging a tiny percentage fee anytime one of their branded cards gets used. When consumers have to pay more for gas or groceries, for example, Visa and Mastercard benefit, as their take from each transaction can rise along with the higher payment amounts.
It also doesn't hurt that they both carry ridiculously high operating margins, while also producing copious amounts of free cash flow quarter in and quarter out.
The last couple years have shined a spotlight on inflation. Looking ahead, investors can find ways to better position their portfolios.
