Why is inflation good for value stocks? 

Be the First to Comment Read

Why is inflation good for value stocks? 

 Why is inflation good for value stocks? 
Image source: g0d4ather, Shutterstock.com

Summary

  • Different groups of stocks perform differently as inflation rises.
  • While the value stocks gain as prices of commodities and services rise, the growth stocks feel the pressure during the periods of high inflation.
  • The stocks overall are more volatile during the periods of high inflation.

Different groups of stocks perform differently as inflation rises. While the value stocks gain as prices of commodities and services rise, the growth stocks feel the pressure during the periods of high inflation.  Saying this, we must also know that stocks overall are more volatile during the periods of high inflation.

Before discussing ahead, we must first understand both inflation and value stocks.

The rise in prices of goods and services used on an everyday basis, including housing and other consumer items, is referred to as inflation. The phenomenon can also be described as a decline in the purchasing power of a given currency over time. In such a scenario, fewer goods are chased by more dollars. Inflation can also be described as the measure of average price change in a basket of commodities and services over a period.

On the other hand, value stocks are the ones that belong to the companies with strong fundamentals. There are value stocks that may no longer be on investors’ radar but continue to have strong fundamentals. The category may also include new companies that are yet to earn recognition among investors. They are considered to carry less risk than the broader market when compared with growth stocks.

READ MORE: How Inflation Affects Your Investments And Finances

Source: © Woodsy007   | Megapixl.com

So, how does inflation impact value stocks?

Value stocks generally get positively impacted with a change in inflation rate in short term. The prices of value stocks are directly related to the inflation rate. So, value stocks tend to do better compared to growth or income stocks when inflation rate rises.

READ MORE: How is inflation calculated?

Higher intrinsic value

Studies show that value stocks are preferred by investors since these have a higher intrinsic value than their current trading price. So, stocks with higher current cash flows become more valuable during a high-inflation period compared to the ones promising returns in the long term. It may happen because of compounding the discount rate in the present value formula.

On the other hand, unlike value stocks, income stocks are unable to keep up with inflation in the short term. Since these stocks pay regular dividends, their prices fall until the dividends surge to meet inflation.

The share prices of multinational companies also see a decline during the periods of rising inflation. The company also runs a risk of becoming uncompetitive if other players in the sector keep the prices unchanged.

The growth stocks too come under pressure during high-inflation periods since these have minimal cash flows. So, they share a negative correlation with the inflation rate.

Source: ©  Smartcoder   | Megapixl.com

READ MORE: What are meme stocks and why are they so popular?

Investors and inflation

The rising prices can both be advantageous and disadvantageous for the economy.  The economy can even grow provided the inflation levels are in control. However, too high levels of inflation can have a detrimental impact on the economy.

The inflation tends to shoot up the cost of living, borrowing and bond yields.

Inflation is viewed differently by different people. For example, those who have invested in real estate or stocked commodity can benefit out of rising asset prices. But the ones with cash can be adversely impacted as inflation reduces the purchasing power of the money.

READ MORE: Three strategies to sail through bubble-like scenario in global stock markets

The bottom line

Even as inflation may have different effects on different categories of stocks, a smart investor always works through a right investment approach during such a scenario. During inflationary times, investors should use a mix of investing styles to reduce his risk to a large extent.

Both growth and value investing complement each other and can help to diversify the investment portfolio when used in unison. However, investors should know when and how to use which approach to reap benefits even during rising inflation.

According to experts, a smart investor is the one who thoroughly evaluates the investment techniques in detail before going ahead with their preferences in the stock market.

Disclaimer

Speak your Mind

Featured Articles