How Inflation Affects Corporate Profit Margins and Investor Returns
Project By: Timothy Yang | Edited By: Timothy Yang
Inflated currency value
In recent years, inflation has become a popular topic of conversation, impacting everything from daily expenses to global investment plans. Most of the population sees inflation when they fill their gas tanks and bags of groceries, but inflation has much deeper effects—especially in terms of finance. Anyone who takes investing seriously should understand how inflation affects corporate profit margins and investor returns.
1. Increased Costs Affect Profit Margins
As inflation rises, so do the costs of goods, labor and services. Companies that are not able to pass higher costs onto consumers in the form of higher prices have to eat those costs and their profit margins shrink, which can impact earnings and stock performance negatively.
2. Consequences for investor returns
While a portfolio might grow, inflation will lower the “real” growth. For example, a 6% return in a year when inflation becomes 4% will only offer a 2% real return!. Inflation also causes volatility in the markets because investors are reacting to changing economic conditions.
3. Winners and losers in an inflationary environment
Businesses that sell products or services with pricing power or inelastic demand (think of utilities or consumer staples) tend to do comparatively better. Alternatively, businesses that have a considerable amount of costs to bear in a down or high price environment with little leverage tend to do considerably worse.
4. Why you should care
In inflationary times you want to invest in businesses that can sustain their margins. In this effective deceleration period you want to think more not only about growth; but durability.
Summary
Inflation doesn’t just raise everyday costs—it also has direct effects on corporate profits and investor returns. As input prices increase, companies with weak price increases may face lower margins which lead to lower earnings and lower stock price performance. Also, for investors, inflation reduces real returns, while volatility in stocks is never good. There are definitely some businesses that do have stronger price increases during inflation or have businesses that are essential—like consumer staples—are less impacted during inflation in general and can maintain earnings while dealing with inflation. Understanding which company’s ability to maintain earnings given rising costs is clearly an important part of your investing process. During inflation the focus is not growth, but resilience, margin protection and respond to a constantly changing economy.
