Playing favorites: 5 top stocks for inflation

Higher prices have been a major headache for investors this year, but these top stocks could help ease the impact of inflation.

  • By Louis Navellier,
  • Kiplinger
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Rising prices have been top of mind for investors all year long. But those worried about the lasting effects of inflation on their portfolios should know that there are several areas of the market that can offer safety amid increasing costs.

Investors seeking out the best stocks for inflation should consider companies that capitalize on current economic, financial and global trends. For instance, inflation is painful, true, but for some firms, such as energy stocks and food manufacturers, higher prices are a boon.

And while some retailers can be hurt badly during inflationary times, others can distinguish themselves in periods of rising costs to win the hearts and minds of investors.

With that in mind, here are five of the best stocks for inflation. There are several reasons these names are top picks. For starters, most have rising earnings estimates from analysts. Say what you will about securities analysts, but there is a strong correlation between their forecasts – and changes in them – and stock prices. Additionally, all of these companies are financially strong players. This is evidenced by their solid balance sheets, as well as the amount of cash they return to shareholders in the form of a growing dividend, a commitment to share buybacks, or both.

Data is as of Aug. 19. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price. Stocks are listed in alphabetical order.

CF Industries

  • Market value: $20.6 billion
  • Dividend yield: 1.6%

Global events seem perilous. If you own CF Industries (CF), which makes fertilizer inputs such as ammonia and urea, they will seem no less perilous, but you will get the kind of satisfaction that comes with knowing you are in the right stock at the right time.

The company is benefiting from growing global demand for and shrinking supplies of fertilizer. For perspective, anhydrous ammonia fertilizer was just over $400 per ton in September 2020. In July 2022, prices peaked at about $1,600 per ton. With natural gas prices still high, and natural gas a large component of fertilizers, these elevated levels can be expected for the foreseeable future.

All of this froth is reflected in CF's top and bottom lines. In the company's second-quarter earnings report on Aug. 1, six-month revenues were $6.3 billion, up 137% year-over-year. And six-month earnings, at a tad over $2 billion, were up 415%. Earnings per share were up 434%, with the extra 16% of margin driven by buybacks/share count reduction.

One advantage CF has over other global producers is that it purchases natural gas domestically, where prices are about 20% of those in Europe. Not all fertilizer producers or the companies supplying fertilizer raw materials can access U.S. supplies.

Also notable in the six-month performance is the improvement in operating margin from approximately 31% in the first half of 2021 to nearly 58% for the first six months of 2022. As sales go up, margins expand significantly at CF Industries.

At the end of 2021, CF's share count was about 207 million, down from 233 million in 2017 and 315 million a decade ago, according to an analysis by Value Line. All this shrinking of the share count increases earnings per share, and puts upward pressure on the stock price.

The wise investor is probably asking if he or she is late to the party for one of the best inflation stocks, which is up more than 137% over the past year and near all-time highs. The answer is maybe, but probably not.

"We continue to believe it will take several years to replenish global grains stocks," says Tony Will, CEO of CF Industries. The grain shortage was provoked by the pandemic, but complicated by the Russian war against Ukraine, with both parties major grain exporters.

But long-term holders might be able to look past the current market dynamics and focus on what the arithmetic is telling them. The company has significant operational leverage at higher sales levels, has grown its dividend 26%, on average, annually over the past decade, according to Value Line, and is buying its stock back at a brisk rate.

Costco Wholesale

  • Market value: $245.6 billion
  • Dividend yield: 0.7%

Costco Wholesale (COST) is a perennial favorite, and for good reason: The company's nimble management team consistently increases earnings in good times and bad. As proof of this, for at least the last decade, Costco has delivered record earnings each year.

Even better, at least for the moment, the company's stock has delivered a tepid performance so far this year, somewhat alleviating the worry investors have about getting in at the top on one of the best stocks for inflation.

There is a moderating point however: Costco trades at a price-to-earnings (P/E) multiple higher than its peers, according to Value Line.

But there's a case to be made that Costco earns its premium valuation. One way it does this is managing the costs of, and pricing for, the goods it sells to customers. Especially now, in an era of historic inflation. In the nine months ended May 8, sales were up more than 16%, but the gross margin, sales less cost of sales, retreated only just 70 basis points, or 0.70%.

Next, Costco is a dividend grower. The dividend is small, about 0.7%, but investors might be encouraged that the company has grown it at an average 13% clip annually for the last decade. This says a lot about astute and prudent management. For really long-term investors, the growth in the dividend can pile up and produce spectacular cash-on-cash returns.

Finally, to get another opinion into the mix, Value Line rates COST A++ for financial strength when looking at items such as free cash flow – the money left over after a company has covered the capital expenditures needed to grow its business – debt and return on equity. The only other retailer to earn an A++ rating is Walmart (WMT), but WMT is a whole different kettle of fish.

Devon Energy

  • Market value: $44.9 billion
  • Dividend yield: 9.1%

The case for Devon Energy (DVN) is that it is operating well in a favorable environment. This can easily be seen on the top and bottom lines, with revenues up nearly 138% year-over-year in the second quarter, and earnings per share up nearly sevenfold.

There are several factors driving an indisputably good earnings report. First, energy prices peaked near $120 per-barrel in the second quarter – up roughly 60% for the year-to-date at that point – against which current financial comparisons are made. So, just by staying open for business, Devon was poised for a big bump in revenues.

On top of rising prices, DVN has increased production and has the reserves to keep doing so. For the most recently reported quarter, Devon delivered about 300,000 barrels of oil per day (MBbls/d), about 4% above the midpoint of its guidance.

Finally, Devon is committed to reducing the company's share count through buybacks. Through the first half of 2022, Devon reduced its share count by 6% via $1.2 billion in buybacks. And the board increased its share repurchase program by 25% in May.

Like many oil companies, the more oil they produce, the better their margins. Devon delivered a $60 "field level" operating margin in the second quarter, versus just over $42 at the end of last year – an increase of 42%. Big is beautiful in the oil patch.

Companies committed to buybacks are often committed to dividend expansion, too, and Devon is no exception. Concurrent with the second-quarter report, Devon announced a $1.55 per-share dividend payment, marking a 22% increase over Q1. DVN employs a fixed-plus-variable scheme for its dividend. In the most recent quarter, 2 cents per share was allocated to the fixed portion, or 13% of the total increase, which investors might see as a sign of confidence by management.

Notably, the current dividend yield for Devon is an eye-popping 9.1% – making DVN the among the best inflation stocks for those seeking income. However, it also indicates that investors are a little more skeptical that the company can keep the oil and the cash flowing. Devon, for its part, remains confident, acquiring Validus Energy in early August for $1.8 billion – giving it greater exposure to the all import Eagle Ford play.

Pilgrim's Pride

  • Market value: $7.3 billion
  • Dividend yield: N/A

Pilgrim's Pride (PPC) is making a meal out of inflation, benefiting from the continuous rise of meat prices and the rise of poultry as the top protein source for many around the world. Even better, costs for raising chickens have fallen, with the cost/output ratio just a third of what it was 30 years ago.

These dynamics are reflected on the top and bottom lines at PPC. Revenues in the six months ended June 30 were up 28%, and earnings arrived at $2.65 per share compared to a loss in the year prior. Since a swing such as this is arithmetically an infinite improvement, consider, for context, that in all of 2021, earnings per share were just $2.28. The last time annual earnings were higher than the most recently reported six-months earnings was in 2017.

Clearly, PPC is on a roll. The earnings performance was driven by a more than 3 percentage-point rise in the gross margin, and from extraordinary growth in the operating margin (from 0.5% during 2021 to 10.3% this year).

The dramatic rise in the operating margin was due to a significant drop in operating expenses, which, in turn, materialized from a variety of legal settlements in 2021. For ESG investors, especially for those with a focus on the "S" part of the equation, the company's list of price fixing and antitrust litigation could be noteworthy.

Shares have had a modest run so far in 2022. For aggressive investors seeking out the best inflation stocks, this is welcome news as the strength in PPC's top and bottom lines appears to have some runway left. Retail is in recovery, which drives demand, but palates are shifting toward chicken worldwide, offering another lift to top-line sales.

Photronics

  • Market value: $1.5 billion
  • Dividend yield: N/A

Photronics (PLAB) makes photomasks, which are templates for the design and manufacture of integrated circuits and flat-panel displays. About 75% of PLAB's revenues come from IC design, with the balance from flat panel displays.

Concerns about the semiconductor industry are understandable. Nvidia (NVDA) recently lowered its revenue guidance due to weakness in its gaming sector. But PLAB's end markets are not tied so closely to discrete markets like gaming. Plus, analysts remain bullish on Photronics, with the consensus earnings-per-share estimate for the current quarter more than double what the company reported in Q3 2021.

Moreover, PLAB is tying its fortunes to much larger market forces. These include the robust demand for integrated circuits and flat-panel displays coming from China for its "Made in China 2025" industrial policy, as well as the U.S. boosting semiconductor production through the CHIPS and Science Act of 2022. Policy in the U.S. and China is driven by the incorporation of chips into the Internet of Things, 5G, crypto and various consumer products to propel its growth.

PLAB is a small-cap stock, with a market value of just $1.5 billion, but recent financial performance has been mighty. For the six months ended May 1, revenues were up 26%, but net income per share was nearly 200% higher to 88 cents per share. Most of the bottom line came with improvement on the gross margin by 11 percentage points, all the more remarkable given increased materials, labor and overhead costs.

While growth is busting out all over at PLAB, hitching its wagon to Made In China 2025 offers opportunity. However, this also creates risks for one of the best inflation stocks due to a volatile geopolitical environment.

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© 2022 The Kiplinger Washington Editors, Inc.
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