An unprecedented emphasis has been placed on outpacing inflation. The repercussions of inflation outpacing wage growth and the return on invested capital have detrimental ramifications. If earned income or the return of capital from investments doesn't keep pacewith rising prices and escalated costs of living, inflation can significantly decrease purchasing power, which could correlate to depleting savings accounts, retirement portfolios, or increased debt levels. The impacts of rampant inflation can become catastrophic unless an individual is well hedged in a portfolio allocation that can outpace inflation.
Todayinflationhas accelerated to 8.5%, which is the highest level on record since December of 1981. Energy prices increased 32%, while food prices jumped 8.8%. It's imperative that people conduct a deep financial analysis of their investments and adjust to the new market dynamic, as cheap capital simply isn't available to companies. Most companies face rising operating costs, declining sales volumes, and shrinking margins as they fail to pass rising costs on to the consumer. During inflation, many cost-conscious consumers shop with a heightened sense of awareness as they look to squeeze every penny out of the dollar. This can mean switching from name-brand items to store brands or eliminating expenses from their monthly budgets.
From an investment standpoint, conventional wisdom indicates that investors should allocate their capital toward resilient consumer defensive businesses that can utilize economies of scale and high pricing power. Companies that fall into these parameters have a greater ability to pass rising costs onto the consumer without incurring declining sales volumes. Traditional investment tendencies are to invest in dividend-paying businesses because their financials are stable and predictable while also adding gold as hedges against inflation.
A dollar today will not buy the same value of goods in 2032, the same way the dollar's purchasing power has changed since 2012. Throughout history, inflation has occurred within market economies, and the only two ways to stay ahead of inflation are to grow your income quicker than inflation rises or by investing in asset classes that can outperform during periods of high inflation. The world has morphed into a global economy as pricing power, and global market reach should be considered when looking for investible assets that can outpace inflation. When it comes to investments, the bottom line is that for every $10,000 of invested capital, you need to finish the year exceeding $10,850 to outpace the current rate of inflation (8.5%). This can come from capital appreciation, dividends, or a combination of both.
Over the previous year, inflation has risen 102.38%, increasing from 4.2% to 8.5%. Nobody has a crystal ball, and there are too many variables and unknown factors to accurately predict how far inflation will rise or how quickly it will subside. The 2021 fiscal year is a great benchmark because inflation was 7% in December. I want to pick companies with the following characteristics:
- Revenue growth outpaced the combination of cost of revenue and total operating expenses
- 3-year track record of increasing net income
- Gross profit margin that exceeds 50%
- Profit margin that exceeds 25%
- Sideways capital expenditure expense with increasing cash generated from operations leading to increased Free Cash Flow
- More cash on hand than total liabilities
These qualifications eliminate almost every individual equity in the market, as only a handful of companies can meet these criteria. I believe Alphabet (NASDAQ:GOOGL) is the best-positioned stock to outpace inflation.
It's Time For A New Type Of "Conventional thinking" Or "Conventional Wisdom"
Yes, it's true that during inflation and even a recession, people will always need to buy food, pay their electric bills, and utilize real estate space. Aspects of technology need to be added to the conventional wisdom around recession-proof or inflationary stocks. Nobody is getting rid of their cell phones; companies will still advertise, individuals will still consume content, and everyone is going to use search engines. It's not 1980 anymore, and the 1980 mentality around what sectors will do well during periods of inflation needs to be updated.
Alphabet is a collection of businesses. The most well-known is Google, which gets broken out into two segments: Google Services and Google Cloud. Within Alphabet's ecosystem of businesses, they own Android, Chrome, Gmail, Google Drive, Google Maps, Google Photos, Google Play, and YouTube, just to name a few. Alphabet has built world-class advertising technologies for advertisers, agencies, and publishers to power their digital marketing businesses. Millions of companies have reached their audience and grown their businesses through Alphabets advertising solutions.
Here are some statistics that illustrate Alphabet's dominance.
Google Chromehas 64.53% in browser market share globally, with Safari coming in 2nd place with 18.84%.
Googlehas 91.56% of the search engine market share worldwide, while Bing comes in 2nd with 3.1%.
Android, which Alphabet owns, has 71.7% of the global mobile operating system market share (smartphones), while iOS from Apple (AAPL) accounts for 27.57%.
When all platformsare taken into consideration, including computers, tablets, and smartphones, Android has 41.56% of the global operating system market share, while Windows from Microsoft (MSFT) comes in 2nd with 31.15%, and iOS comes in 3rd with 16.85%.
As an honorable mention,Google Cloudhas 9% of the worldwide cloud infrastructure spend, which places them in 3rd place behind Azure from MSFT with 22% and AWS from Amazon (AMZN) with 33%. This is significant because YOY Google Cloud has increased its revenue by 47.07%, and over the next 8 years, the worldwide cloud infrastructure spend is expected to increase to $1.55 trillion. If Google Cloud can maintain a 6.5% market share in 2030, it would place Google Cloud's revenue at $100.75 billion.
Technology is embedded into society, and Alphabet owns and operates the 3rd largest cloud infrastructure platform and the most used browser, search engine, mobile operating system, and overall operating system. It doesn't matter if we experience higher inflation, a recession, or even a depression; these products from Alphabet will be used by billions of people daily.
The Risks Of Investing In Alphabet
No investment comes without some degree of risk. While I am very bullish on Alphabet, some risks should be considered. In2018, the EU had fined Alphabet $5 billion for manipulating Android mobile devices to give the Google search engine an advantage over rivals. In2021, the EU's General Court upheld a European Commission ruling against Alphabet for antitrust infractions, and they are facing another $2.8 billion fine. Alphabet has also had its share of problems stateside as theU.S. Justice Department and 11 stateshad filed a lawsuit in 2020 alleging that Alphabet used its market power to fend off rivals.
When you consider Alphabet's dominance, especially since Google Chrome has 64.53% of the global browser market share and Google has 91.56% of the search engine market worldwide, the word monopoly becomes synonymous with Alphabet. It gets even worse when Android enters the conversation, as it has 71.7% of the mobile operating system market share worldwide.
While Alphabet can pay billions in fines and not feel the repercussions, it's putting them right in Washington DC's crosshairs. Alphabet has been on Capitol Hill and testified more than they would like. A common theme among some lawmakers that has gained traction is Alphabet has become a monopoly. Alphabet faces the risk that its conglomerate is forced to break up if they are deemed a monopoly by the United States Government. If political opposition continues to grow, Alphabet could find themselves on the hill more frequently and pressures from DC could intensify with an unfavorable ruling against Alphabet.
Conclusion
The old school mentality of which sectors should be your defensive plays during volatility, inflation, or recessions needs to be revisited and rewritten. The world in 2022 is completely different than the late 70s and early 80s when inflation was at these levels. The best companies during hard economic environments are ones that are growing revenue, gross profit, net income, FCF, and EPS while maintaining strong balance sheets. Alphabet checks off all of these boxes in spades.
Utilities have always been a safe haven, and I am a shareholder of Southern Company(SO), but when it comes down to it, Alphabet generated more in net income ($76.01B) than SO did in revenue ($22.41B) throughout 2021. I think 2022 will be a huge year for Alphabet; the stock split will drive volume, and earnings will be extraordinary. These are why I am currently a shareholder; I plan to buy more and will be using shares of Alphabet to beat inflation.
Source: seeking alpha
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