With inflation on the rise, investors are on the prowl for ways to beat it and protect their wealth. After all, if everyday prices start climbing, the value of nest eggs becomes that much smaller. A common go-to strategy in the fight against inflation is to simply buy gold. Yet, Warren Buffett, one of the world’s most successful investors, believes there is a much better way to protect and grow capital during times of higher inflation. Let’s explore the Oracle of Omaha’s approach.
Beating inflation with stocks
Being a stock market investor, it should come as no surprise that Warren Buffett’s inflation-beating strategy revolves around buying shares. Specifically, he’s looking for companies with two primary traits. The first and most obvious is, of course, to only buy shares in high-quality enterprises. This is a rule that all long-term investors should be following since mediocre or average businesses eventually crumble or simply stagnate versus the market. At least, that’s what I’ve seen.
But when it comes to beating inflation, a high-quality business may not be enough. Having low capital expenditures is also vital. Let me explain. A company that is heavily reliant on third-party suppliers for raw materials or services could struggle. That’s because these firms often have next to no control over such expenses. And with inflation pushing up prices, profit margins start feeling the pressure.
That’s why companies with high gross margins and a strong level of control over operating expenses are more likely to thrive during inflationary periods. But even if a firm has virtually no control over its costs, it’s still possible to beat inflation if it has another crucial quality.
Warren Buffett’s #2 inflation-beating trait: pricing power
As previously stated, the problem with rising raw material costs is that margins get squeezed. But that’s only true for the companies that can’t raise prices without losing customers to a competitor. A firm with pricing power can offset inflationary pressures by simply passing on the additional cost to customers.
Needless to say, this can mitigate or outright cancel the value-destroying effects of inflation for a business and its shareholders. So, it should come as no surprise that Warren Buffett has described pricing power as “the single most important decision in evaluating a business”.
So, why not gold?
Despite Warren Buffett’s negative stance on the precious metal, many institutional and individual investors continue to use gold to hedge against inflation. Why? Because it works.
However, personally, I believe stocks are still the better strategy of the two. After all, gold may help protect wealth, but it’s not very good at growing it, as the metal doesn’t generate cash flows, nor does it produce any goods or services. Only businesses do that. And by buying shares in high-quality firms that have control over expenses along with pricing power, I can beat inflation as well as grow my portfolio at the same time.
The post Warren Buffett uses this simple strategy to beat inflation appeared first on The Motley Fool UK.
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