Picking shares to beat inflation – an HL Fund Manager’s view

Inflation is back. The Bank of England sees it hitting double digits when the next big jump in gas and electricity prices hits home in the autumn.

Businesses face the squeeze too, with pretty much all of the inputs that companies have to buy, going up in price. It adds up to pressure on living standards for consumers and a potential squeeze on profit margins for businesses.

Investors have to think to the longer term at times like this. The immediate future could be painful, but cash is no haven when inflation is so high. History has shown investing in the stock market is a great way of generating long-term returns, even when markets have their wobbles along the way. All the same, only invest the money you can be confident you will not need in the next five years or so. This gives you the ability to ride out any bumps in the road.

The impacts of inflation can be unpredictable. In recent days, we’ve seen it upend the apple cart for companies as diverse as insurers, where claims values are outpacing premiums and an advertising agency, where cost controls have proven inadequate, slashing profit margins.

Spreading your risks is vital. Diversifying your portfolio across industries and countries could help you achieve this. This applies just as much to investors using funds as those who prefer to buy shares directly.

The lesson that I’ve learned most strongly over a 35-year career in the stock market is that the shares of resilient businesses are the best long-term investments.

This article isn’t personal advice. If you’re not sure what to do, ask for financial advice. All investments fall as well as rise in value, so you could get back less than you invest.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

1. Ditch the debt

   Now is no time to be borrowing heavily. The cost of debt is fast rising. Companies with high borrowings will see the cost of these rising and might be more likely to struggle. Debt endangers dividends, for banks have a right to be paid back, but shareholders have to stand at the back of the queue.

2. Pricing has power

   It’s the investor’s best defence right now. Great businesses have products and services that are so valuable that customers will tolerate a price increase. Pricing power requires a degree of uniqueness. Me-too products have to sell on price.

3. Cash is king

   Even in republics, cash is king. I look for businesses that reliably generate cash in excess of what they need to plough back into the company each year. They have freedom to choose what to do next. Hopefully that will usually be more of the same, just better.

4. Repeat business

   Recurring revenues are better than one-off sales. Finding new customers when everyone is trying to hide from the inflation monster is not going to be easy. I aim to back companies where the customers keep coming back, that could be for subscriptions to software or data services, or essential items like groceries or beverages.

5. Capital-lite is alright

   I’ve long been fond of companies that exploit the value of intellectual property. Businesses that make big, physical items need big factories, big machines inside them, which can all add up to a big cost base, every part of which is liable to inflation. Companies that exploit intellectual property, perhaps selling software, data or advice, can often run with limited fixed assets and high margins. Their earnings can be more resilient to cost pressures.

6. Look at their history

   See how companies fared in previous periods of economic challenges. If a business took a big hit to profitability last time around, it could this time too.

Following these principles when stock-picking should create a portfolio with staying power, containing companies that should have fighting chances of getting through this bout of inflation with their real value preserved.

Steve Clayton is a Fund Manager of the HL Select range of funds.

The HL Select funds are run by our sister company Hargreaves Lansdown Fund Managers Ltd.

FIND OUT MORE ABOUT HL SELECT