Stocks Remain Your Best Bet, but It Pays to Choose Wisely

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The CPI numbers this week shocked many on Wall Street (8.3% overall increase from the prior year versus an expected 8.1% and 6.3% in the core group that excludes the most volatile food and energy segments). In fact, the only reason for cheer was energy, which while remaining double-digits above the year-ago level across categories, did see notable monthly declines in gasoline and fuel oil. Food was a different story however, because while decelerating from July, prices continued to increase substantially last month.

And the verdict was clear: there is most certainly going to be a 75 bp increase in the Federal Funds Rate on Sep 21. Another 75 bps hike before the year is out is also looking like an increasing possibility.

That means loans and mortgages are going to get more expensive, putting new homes even more out of reach, which in turn will keep pushing home rentals, and thereby, inflation up. The only hope for a material change in this scenario is significant inventory build, which won’t happen until many more buyers exit the market.

While new apartments coming up is a positive indication of impending inventory increase, it’s worth remembering that only about a fifth of the market consists of new homes while existing homes account for the rest. So, we can’t get to the peak until more buyers exit. And hopefully that will happen instead of more home owners getting sucked into the renting market where returns are climbing. Because if that happens, there will be inventory cuts in housing that will only serve to further raise prices.

New and used vehicle prices are moderating although still notably higher than a year ago. But it’s obvious that the supply-side issues that were plaguing the auto market earlier are normalizing. And that is good for moderation in prices.

However, transportation bottlenecks remain in some areas and labor tightness is part of the problem, which sends prices higher.

With most people traveling again even as labor and capacity remains tight, services and food away from home are also seeing an uptick.

Given the high level of inflation, Americans are likely to get more debt-ridden, and this will most likely show up as rising balances on their credit cards. These balances have anyway risen post a rather enthusiastic summer, but things are likely to get worse before the year is through. Higher debt is good for the lending banks and other financial institutions, so the environment is relatively positive for the finance sector.

The thing that is making the inflation rate sticky is the condition of the labor market. With talent remaining scarce, job openings remaining high and wage rates continuing to increase at quite a rapid pace, employers are loath to let workers go, even if they see their sales falling. This in turn keeps the heat up in the labor market. Technology is the only sector that has been cutting headcount, but most of the cuts are coming from the largest companies that have the wherewithal to hire back people at competitive rates when the markets are again conducive.

So should you be investing in stocks?

There are a couple of arguments that favor investment in stocks rather than holding cash or other asset classes.

Number one is the cost of holding cash. In an inflationary situation, the value of money is declining and by holding on to cash you’re essentially losing its value. Therefore, it’s a much better idea to invest in something that has some chance of appreciation, hopefully to keep pace with the rate of inflation and at least to minimize losses from it. Putting something into your 401(k) or IRA account also helps to save taxes. Holding too much cash is definitely not a good idea.

Investing in fixed income assets comes with lower risk because your returns are known. But it’s only the equity markets that provide adequate returns over the long term. That’s why stocks are the best place to keep your money.

The current environment is not the best time to invest because there will be more downside in the markets, not only this year but perhaps more so next year. On the other hand, because of the reasons mentioned above, it’s your best bet. So instead of staying away from the market, it’s better to stay invested.

Just make sure to choose stocks that are better positioned to stay ahead of inflation and that also have strong financials. Let’s take a look at some examples:

Industrias Bachoco, S.A.B. de C.V. (IBA – Free Report)

Industrias Bachoco, S.A.B. de C.V. is primarily a poultry producer in Mexico and the United States. It is primarily involved in the breeding, processing and marketing of chicken, eggs, swine, balanced animal feed, and other meat products. The company also produces and distributes pork, fish, turkey, pet food, cattle and beef products, as well as medicines and vaccines for animal consumption. It sells its products through wholesalers and retailers, as well as directly to supermarkets and foodservice operators.

Food is an essential item and is likely to remain resilient to inflationary pressures as well as the impending recession, or soft landing, or whatever happens over the next year or so.

The Zacks Rank #1 (Strong Buy) stock beat the Zacks Consensus Estimate by 168.8% in the last quarter. The 2022 estimate is up 32.1% in the last 60 days. The 2023 estimate is up 10.7%.

Industrias Bachoco’s net cash per share has increased in every quarter between Jun 2020 and Jun 2021. And after dropping off in the last two quarters of 2021, it has picked up again this year. The book value, including tangible book value per share has also increased sharply in recent quarters, indicating that the company added to its asset base in the face of increasing demand. Understandably, because of the increase in the asset base, there was a temporary reduction in the return on assets. But this too has reversed and jumped nicely in the last quarter. Having paid off all its debt earlier this year, the company appears to be on solid financial footing,

Daqo New Energy Corp. (DQ – Free Report)

Shanghai-based Daqo New Energy manufactures and sells polysilicon to photovoltaic product manufactures in the People’s Republic of China. Its products are used in ingots, wafers, cells and modules for solar power solutions.

With demand for energy going through the roof, countries are trying to build as much solar capacity as they can. And the company’s financials show how this clean energy is boosting its results.

The Zacks Rank #1 stock beat estimates by 26.6% in the last quarter, after which the 2022 estimate increased 6.4% in the last 60 days. The 2023 estimate increased 31.0%.

While Daqo has been increasing its net cash per share since 2020, it has accelerated sharply this year. The concurrent increase in its tangible book value indicates that it has also expanded its asset base. Barring a dip in the Dec 2021 quarter, the return on assets is also showing a steady upward trend, so money invested is fetching good returns. After paying off all its debts in the September 2021 quarter, the company is on solid financial footing.

Encore Wire Corporation (WIRE – Free Report)

Encore Wire Corporation manufactures and sells interior electrical wiring for homes, apartments and manufactured housing; and for commercial and industrial buildings in the United States. Products are sold to wholesale electrical distributors primarily through independent manufacturers’ representatives.

The housing market remains very hot as described above although mortgage rates rising to 6% will definitely make things tougher on home buyers. But electrical wiring is just as important in the remodeling segment, and as more people move back to work, demand will also increase in the commercial and industrial segment. This is borne out by the strong numbers.

After Encore Wire beat the Zacks Consensus Estimate by 158.1% in the last quarter, analysts raised the 2022 estimate by 40.0%. The 2023 estimate increased 5.9%.

Encore Wire’s net cash per share did suffer through 2020 and into the March quarter of 2021. But after that it has picked up strongly to well above the pre-pandemic period. The sharp increase in the book value per share, including the tangible book value per share reflects how net PPE has increased during this period.  Return on assets also shows a positive trend since the pandemic hit and especially since Jun 2021 although there was a slight dip in the last quarter. The company has no debt.

One-Month Price Performance

Zacks Investment Research
Image Source: Zacks Investment Research

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