Outsmart the Future? Look to the Past

By Kyle Campbell - May 23, 2012 | Tickers: KO, PEP | 0 Comments

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I hate to make macroeconomic predictions, but sometimes current events remind me all too much of previous periods in our history. Massive government deficit? Check. Rising commodity prices? Check. An unpopular and costly war? Check. These three issues that we see today were also seen back in the late '60s, just as the Vietnam War was coming to an end. As you can see in the chart below, inflation skyrocketed in the 5-7 years post-war. With operations in Iraq ended and those in Afghanistan coming to a close, I feel we may be in for a repeat of history.

 Source: http://www.ritholtz.com/blog/2008/08/variation-on-the-gdpinflation-chart/                                                   

 When people think of investments for a pending inflationary environment, most think gold and commodities. Me? I prefer stakes in companies with attractive characteristics. I think of strong brands, pricing power, and global sales. First, a company with strong brand recognition will be able to keep their consumers buying its products. Also, if that same company has pricing power, management can continue to successfully pass increased material costs on to the consumers. Finally, global sales help to shield a company from inflation by diversifying its income streams. For example, the United States may experience inflation while, at the same time, Asian countries are experiencing no inflation.

 My first investment choice for an inflationary environment is Coca-Cola (NYSE: KO). The company, incorporated in 1892, has seen its fair share of difficulties. Despite experiencing two World Wars, the Great Depression, inflationary and deflationary environments, increased competition and marketing SNAFUs, Coca-Cola remains a thriving business and arguably the world’s greatest brand. Having such a fantastic brand has allowed the company to increase its daily soft-drink sales from 6.5 million drinks in 1920, to 1.5 billion in 2008.

Now, two things I love about Coke are the economics of the business and its pricing power. Because of its great distribution network, the company has the ability to take newly invented or newly acquired beverages and quickly place them in the hands of consumers around the globe. In addition to this, Coke enjoys pricing power, which enables it to keep up with inflation and rising material costs. If you go to the company’s website and look at the bottom of the page, you can see a very large number that continuously climbs. That is the number of servings of Coke products consumers are enjoying so far that day. As I am writing this, the number stands at approx. 1.6 billion beverages sold. Now, if the company were to raise the price of each drink by just one penny, revenue would increase by $16 million each day!

Source: http://www.cnbc.com/id/33401930/The_Evolution_of_an_American_Icon?slide=4

Since we mentioned Coke as a good candidate, the obvious next step would be to take a look at PepsiCo (NYSE: PEP), a very similar business and my second choice for an inflationary environment. Pepsi differentiates itself from Coke in a number of ways, the most obvious being its snack food line. Fritos, Tostitos, Ruffles, and Doritos are only a few of the many delicious brands owned by PepsiCo. I think it is also worth mentioning that the company currently holds 22 different product lines, each of which generates more than $1 billion in annual revenue. Talk about recognizable brands!

Despite its recent difficulties in the soft-drink market, I believe PepsiCo is a solid choice to combat future inflationary pressures. The company’s diverse holdings of strong brands can help maintain income if one particular line of products experiences a rough patch. Also, the same pricing power we saw with Coke applies here. Because of its relatively low-cost products, customers are less likely to react to incremental price increases; a nickel increase can easily go unnoticed. In addition to pricing power, the company sells its products worldwide, effectively protecting itself from inflation in a single country.

Finally, I would like to mention an investment that fits in an inflationary environment, but does not pertain to the stock market. With interest rates for 30-year mortgages at all-time lows and housing prices well off their frothy, housing-bubble valuations, now might be the best opportunity to purchase a new home. In a high inflation period, building material costs will climb, which will, in turn, cause house prices to rise. Not only do you get very cheap, long-term leverage, you also get the real possibility of price appreciation on the house.

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