Equity investors shouldn’t worry too much about this year’s spike in inflation, as history shows few asset classes are as effective at keeping up with – and beating – rising prices over the long term.
This is according to James Bullock, co-manager of the Lindsell Train Global Equity fund.
The consumer price index (CPI) in the US fell from its peak of 9.1% in June to 8.3% in August, but this was above expectations and still close to 40-year highs. In the UK, the figure stands at 9.9%.
These figures have prompted many investors to look for assets with some form of in-built inflation protection, such as property, infrastructure or gold.
However, Bullock claimed you need look no further than equities for inflation protection, due to their “participation in real economic value creation and hence promise to protect purchasing power over long periods of time”.
“This is a claim we’ve often made, with particular reference to companies with strong brands and pricing power, as typified by the best of consumer staples,” said the manager.
“However, given the present environment, we thought some supporting numbers might help.”
As a result, the team at Lindsell Train examined the investment reports of several portfolio holdings going back to 1965. Bullock described the following half century as a “wild inflationary ride”, pointing out that while analysts are currently panicking about high-single digit inflation, US CPI exceeded 12% per annum (p.a.) across three separate years during the 1970s.
US inflation has averaged 3.9% per annum since then, causing a dollar stashed under the mattress to lose nearly 90% of its purchasing power, equivalent to more than an eight-fold rise in prices.
“Inflation really is worth beating,” said Bullock – before pointing to one portfolio holding, PepsiCo, as an example of a company that has done just that.
“In 1965 (the year Pepsi acquired Frito-Lay, arguably morphing it into the modern company it is today) a six-pack of Pepsi Cola could be had for the princely sum of 59c, meaning you paid just under 10c per bottle – already a big jump from the famous fixed 5c charged throughout the 1950s,” he said.
“Today the US list price of a Pepsi is a cooler $2.05. That’s a 21-fold increase (or 5.6% p.a.) in pricing, and confidently ahead of inflation. Real goods protected by strong brands command real pricing.”
While Bullock said he could stop there, he referred to the corresponding growth in PepsiCo’s business as “the true prize”.
The manager said that, shielded by such pricing, Pepsi’s M&A-enhanced volumes have grown as it has conquered new countries and expanded distribution.
“Revenues have grown (organically and inorganically) from $510m in 1965 to more than $79bn by 2021; a 156-fold increase at a 9.4% annualised rate,” he continued.
“With the margin ticking up from 11% to 14%, operating profits have grown 192-fold to $11bn, at a 9.8% per annum rate. Consequently, any long-term investors seeking real cashflow growth will not have been disappointed.”
Share data only goes back 42 years, over which time Pepsi’s buy-and-hold investors received a 34,500% total return, while the MSCI North America and MSCI World delivered 4,800% and 3,200% respectively.
Performance of stock vs index over 40yrs (share price only)
Source: Google Finance
The obvious riposte to these figures is that past performance is not a guide to future returns, and just because PepsiCo has been a great investment in the past, it doesn’t mean it will continue to deliver. This point is especially pertinent in an age of accelerated disruption, when the digital revolution is changing the way we shop, work and interact with each other.
However, Bullock said that if the first half of 2022 is anything to go by, “21st century Pepsi is doing fine”.
“With first half organic volumes steady (+2.5% year on year), the company managed to increase prices by 11%, growing overall organic revenues by 13%,” he explained.
The manager said that consumer staples are not the only evidence of pricing power in his portfolio – just the most topical in view of recent manufacturing input cost surges.
Performance of fund vs sector and index since launch
Source: FE Analytics
“In fact, every company we own can demonstrate it in one way or another,” he continued.
“For example, PayPal’s June announcement showed that it had ‘simplified’ its fees – and yet its second quarter results signalled further gains in both market share and adoption.
“Look out for more such announcements in the coming months and indeed years. Whatever rate our current inflation spike settles down to (we deliberately use real metrics in our valuations to save us having to predict such things), we’ll look to our companies to shield us, just as they have in the past.”