With inflation rising, investors are looking for ways to overcome it and protect their wealth. Because when the daily prices rise, the value of the nest egg becomes much lower. A common strategy for fighting inflation is to simply buy gold. However, Warren Buffett, one of the most successful investors in the world, believes that in times of higher inflation there is a much better way to protect and grow capital. Let us examine the oracle of Omaha approach.
Beat inflation with stocks
As a stock market investor, it should come as no surprise that Warren Buffett’s anti-inflation strategy revolves around buying stocks. Specifically, he is looking for companies with two main characteristics. The first and most obvious, of course, is to only buy stocks of high quality companies. This is a rule that all long-term investors should follow because mediocre or average companies will eventually collapse or simply stagnate against the market. At least that’s what I saw.
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But when it comes to beating inflation, good quality business may not be enough. A low investment outlay is also of crucial importance. Let me explain. A company that relies heavily on third-party suppliers for raw materials or services could face difficulties. This is because these companies often have little control over such expenses. And as inflation drives prices up, profit margins are starting to feel the pressure.
Because of this, companies with high gross margins and strong control over operating costs are more likely to thrive in periods of inflation. But even if a company has virtually no control over its costs, it is still possible to overcome inflation if it has some other crucial trait.
Warren Buffett’s # 2 anti-inflation property: price power
As mentioned earlier, the problem with rising raw material costs is that margins are squeezed. However, this only applies to companies that cannot raise prices without losing customers to a competitor. A company with pricing power can offset inflationary pressures by simply passing the additional costs on to customers.
Of course, doing so can mitigate or cancel out the destructive effects of inflation on a company and its shareholders. It should come as no surprise, then, that Warren Buffett described pricing power as “the single most important decision when it comes to valuing a company.”
So why not gold?
Despite Warren Buffett’s negative stance on the precious metal, many institutional and retail investors continue to use gold as a hedge against inflation. Why? Because it works.
Personally, however, I believe stocks are still the better strategy of the two. After all, gold can help protect wealth, but it’s not very good at increasing it because the metal does not generate cash flows, nor does it produce any goods or services. Only companies do that. And by buying stocks of high quality companies that have control over spending in addition to pricing, I can beat inflation while growing my portfolio.
But which stocks meet these criteria? Well, here’s one that I think could generate explosive growth and marginalize inflation …
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Views on the companies mentioned in this article are those of the author and therefore may differ from the official recommendations we make on our subscription services such as Share Advisor, Hidden Winners, and Pro. At The Motley Fool, we believe that taking a variety of insights into account makes us better investors.