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Share investment ideas

3 share ideas for lower inflation

With inflation expected to fall further despite the recent surprise, we look at 3 share ideas that could still benefit.

Important information - This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Even with December's bump in inflation, it’s still fallen massively from its 11.1% peak in October 2022. This has been a welcome step in the right direction, but it might be a while before things are back in line with central bank targets.

Lower inflation means that costs are coming down for businesses. But the higher interest rates and inflation staying sticky in some corners, means this isn’t a free pass for companies to easily inflate their margins this year.

The longer inflation lingers, the longer the Bank of England might need to keep interest rates higher, running the risk of a recession. Here are three companies that we think could benefit in the current economic environment.

Investing in an individual company isn’t right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you’re investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.

This article isn’t personal advice. Investments and any income from them can fall and rise in value, so you could get back less than you invest. If you’re not sure if an investment is right for you, seek advice. And remember, past performance isn’t a guide to future returns.

American Express

Cooling inflation might be helpful for consumer behaviour, and therefore spending. That’s why we think it could be a good idea to consider a credit company like American Express (Amex).

While improving consumer confidence is a tide that lifts all ships, we like Amex’s focus on premium customers. It makes it stronger than other providers in the face of consumer slowdowns.

Amex’s so-called delinquencies (the rate at which customers have been falling behind on payments) are now lower than pre-pandemic. That’s a strong result. Last quarter, total member card spending was up 7%, and spending in the US was up 9%. This suggests a strong consumer backdrop.

Its broader portfolio focuses on an integrated payments platform, card issuance, and most importantly in our view, its membership model which has helped make a unique and powerful brand.

Even with difficult broader conditions, Amex saw record uptake of the US Consumer Platinum and Gold Cards, as well as Business Platinum last year. That’s a result of the group’s shrewd efforts to be linked with lifestyle benefits as well as its strong core card offering.

We think this payments giant offers something exciting and a bit different, backed up by a sturdy financial position. The group generated about $19.2bn in free cash flow last year, and the balance sheet is also looking healthy.

Investors should keep in mind that although Amex is in a stronger position, it wouldn’t be immune to a sharp consumer slowdown. A recent increase in the valuation also means the market has high expectations, increasing risk.

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The grocers have been hit hard by inflation. The cost of food shot up by double digits and the big supermarkets were left struggling to strike a balance between affordability and protecting margins. Now that inflation’s calming, it throws up a whole new challenge. Shops need to be able to shift higher volumes of goods to keep the topline moving.

We think Tesco has a best-in-class offering. Recent results show sales are up over 6% and the group’s lower exposure to general merchandise, which is more at risk to lower consumer spending, puts it in a strong position.

People need to put dinner on the table no matter what, so there’s some reassurance over demand. Tesco’s better-than-expected performance recently means the group’s expecting to generate £2bn in retail free cash flow. That supports Tesco’s ability to invest in staying competitive and helps underpin the attractive 4.5% prospective dividend yield. But remember, no dividend is guaranteed.

There are things to keep an eye on though. A continued preference for lower-value goods could pressure margins and free cash flow if volumes don’t outpace overall price growth. This is more likely in the face of a sharp economic downturn.

We don’t think Tesco’s valuation of 11.3 times expected earnings fully reflects the group’s income potential and attractive nature of its demand. There could still be some bumps along the way depending on how the economic landscape shakes out.

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If a scenario pans out that sees inflation continue to slow, we could see interest rates in the US cut in the short to medium term.

Lower interest rates and inflation tend to link to businesses spending more on things like technology. Whether that’s cloud computing, cyber security or powerful analytics and everything in-between, the likes of Microsoft are poised to capture that demand.

Microsoft’s cloud platform Azure has seen impressive growth over the last few years. The group’s also exposed to consumer spending via its hardware. Things like laptops and the software bundles that go on multiple different brands of computers, could stand to benefit as and when the economy reignites.

And if inflation proves to be stubborn, other areas of Microsoft’s broad product offering stand to benefit. The solutions it offers helps companies boost efficiencies.

Microsoft’s valuation has also seen an astronomical boost in the last year as artificial intelligence (AI) excitement ramped up.

In the case of a soft economic landing, more highly valued stocks are also in a better position than when times are tough. The risk-reward profile is easier to stomach and in a more bearish scenario AI is expected to be a disinflationary tool over time.

All share prices can go down as well as up in value and there are no guarantees.

Remember, before you can trade US shares, you need to complete and return a W-8BEN form.

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The incoming Chair of Hargreaves Lansdown plc is a non-executive director of Tesco.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views might have changed since then. Unless otherwise stated, estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates aren’t a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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Written by
Sophie Lund-Yates
Sophie Lund-Yates
Lead Equity Analyst

Sophie is a lead on our Equity Research team, providing research and regular articles on a selection of individual companies and wider sectors. Sophie's specialities are Retail, Fast Moving Consumer Goods (FMCG), Aerospace & Defence as well as a few of the big tech names including Facebook and Apple.

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Article history
Published: 2nd February 2024