So let's talk about the hot topic right now:

INFLATION & HOW TO BEAT IT!

So on Friday, inflation came in worse than expected at 8.6% which was above the 8.3% expected from the market. It's the highest reading since 1981, so the market freaked out and the stock market tanked 3% on Friday.

Now a bit of good news is that Core CPI — which excludes food and energy — has been going down the last 3 months, from 6.5% in March, 6.2% in April, and now 6.0% in May.

But who cares?

Because energy and food are the main part of people's expenses and that is still going up, and the FED really can't do much about it right now. So is this bad news?

The Riskiest Investment Is In CASH!

It's really bad news if you're HOLDING CASH because if you are holding cash, it's the riskiest investment to be in because if you're holding cash you're guaranteed to lose money over time.

Now inflation's not gonna stay at 8% forever. It's gonna come down maybe not to 2% for a while, but at least down to 4%.

At a 4% inflation rate, our money falls by 4% every single year because our money buys fewer goods. So if you're losing 4% each year and if you compound that, that means every 10 years you are losing 33% of your purchasing power — of your wealth. In 20 years, you'd lose almost 40% of your wealth!

Now that's just at a 4% inflation rate. If it stays at 8%, what happens? 

It's highly improbable for it to stay at 8%, but if it does, you'd lose 33% of your wealth every 5 years and 40% of your wealth every 10 years. That's why holding excess cash is the riskiest thing that you can ever do.

Now let me clarify, first of all, you need enough cash to pay your short-term expenses so never invest your last dollar. Cash is like oxygen — you always need enough oxygen around. Without oxygen, you'll die. So you need to have enough cash for your short-term expenses of at least 6months minimum.

So I tell people "Only invest the surplus that you don't need in the short term."

Now whenever I tell people that cash is risky to hold, people say that I'm nuts. Yes if I hold cash I'm down 8%, but if I hold stocks I'm down 30%, that's even worse right. If I hold cryptocurrency, I'm down like freaking 50%! Isn't that worse?!

So understand that in the short term in the very short term when the market freaks out, if you hold stocks it'll go down more than if you hold cash. So it looks like cash is safer and stocks are riskier — that's what it looks like in the short term, but over time you'll find that holding productive assets like BUSINESSES & REAL ESTATE will beat inflation and they'll grow your wealth.

That's a guarantee that has happened for the last 120 years.

Now a lot of people think since cash is losing value, they'll go into cryptocurrencies. I've said this many times, in my opinion, crypto is not the answer because, in the long run, the majority of crypto assets are worthless — they're all going to go to zero.

We Must Invest In Businesses & Real-Estate

So the only way to preserve your wealth and beat inflation is by holding productive assets — assets that generate cash flow like real estate and businesses.

If you take a look at the longer-term performance of businesses or the stock market, it outperforms any other asset class, and most importantly, IT BEATS INFLATION!

So if you look at the S&P 500 over a longer-term period, over the last 30 years, you can see that despite the Dot-Com crash, the Great Financial Crisis, and the Covid crash, taking all that into account and if we just hold it through those short term ups and downs, over the long run we would have seen a capital gain of +1,346% of our cash!

That's about a 9.3% return a year, capital gains.

If we include the dividends, which is about 2.65% dividends, our total annual return would be about 11.96% a year!

So in other words, if you just hold the S&P 500 Index over the long run you're getting about 11% to 12% a year with dividends re-invested, and that's way above even this 8% inflation rate.

Now, how about other assets?

If you compare the S&P 500 (the US stocks) it outperforms real estate, and it outperforms gold as well. So businesses give the highest returns over the long run, and so holding stocks are the best hedge against inflation.

Now some people say, "But Adam if that is true, why did stocks fall when we had high inflation data? Shouldn't stocks go up if stocks are good for holding in inflation? That doesn't make sense, right?"

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Why Stocks Fall In The Short-Term

So let me explain why in the short term the market tanked. The reason stocks fall in the short term is because of these 3 things:

Number #1

When you've got high inflation, it suggests a higher business cost. When their costs increase, they've got lower profit margins and that's why the market freaks out. With lower profits, people would sell their stocks and the market comes down.

So is this true for all businesses?

The answer is no for businesses that are not able to raise their price easily because they're in a very competitive industry, like the auto industry and airline industry — they're very competitive and they can't raise their prices as easily. That's when their profit margin falls, and that's when these businesses will start bleeding.

That's why we should only invest in companies that have got pricing power.

Pricing power means that they are able to raise their prices to pass on the cost to their consumers. So if their costs go up, they can raise prices to maintain their profit margins.

So what kind of companies have pricing power?

These are companies that have a brand monopoly; a brand that people are willing to spend more on, like Estee Lauder, Nike, Louis Vuitton, and Apple products for example. So only focus on stocks with pricing power.

As costs go, up raw materials costs go up, and commodity costs go up, companies that have to spend a lot on capital expenditure to maintain their operations, will suffer as well. So again airlines, auto manufacturers, and construction companies — have to keep spending a lot of money to maintain their factories, plants, and machinery. So these are companies that would suffer from higher costs of doing business.

So if we want to really beat inflation, we have to buy companies that have pricing power, that can raise prices, and have low capital expenditures.

For example, if you take a look at McDonald's and Domino's Pizza, they've got little or no CAPEX because it's their franchisees that pay for opening the shops and pay for the employees. McDonald's and Domino's just collect the franchise fees. They don't actually come up with the money to open the shops.

Look at technology companies like Microsoft for example. Once they've got the infrastructure, they don't have to spend more and more on CAPEX to maintain it to raise their sales & profits.

Number #2

The 2nd reason why stocks fell on Friday is that higher inflation suggests that the FED will have to raise interest rates faster.

Now is that bad for businesses?

For some, yes, but not for all businesses.

So what kind of businesses will suffer when interest rates rise?

The answer is companies that are not making any money now!

So companies like  ROKU, PELOTON, and TELEDOC, a lot of the ARKK Invest companies, don't make money right now. They are hoping to make money in the future, in 5-10 years.

So with these kinds of companies, when you have high interest rates, you have to discount the future cash flow to the present value. And a higher discount rate lowers the present value of the future cash flows. In other words, it makes these companies worth a lot less today.

That's why I keep saying "Avoid companies that don't make money now!"

These are like the frogs that you kiss that you hope would turn into a prince, but these frogs are in trouble!

They are boiling because of high interest rates. So we only want to own stocks that make money right now, that have got high profits and high free cash flow right now because they are not as affected by high interest rates.

Now at the same time, people say "Adam, with higher interest rates, will companies with high debt suffer?"

Well yeah, in a way. Companies with a lot of debt have to pay more and more interest on their debt. That increases expenses, and if they can't refinance the debt, they could go bust.

But what is the meaning of too high debt or too low debt?

It's a bit subjective, so what's more important is to look at the cost of debt. For companies that have a high cost of debt, you want to avoid them because they're in trouble.

So how do we measure this?

So what I look at is what is known as 'RETURN ON INVESTED CAPITAL (ROIC) and I'll show you some numbers later. Every business has an ROIC. It tells you how much money it generates from its capital. As long as the ROIC is higher than the cost of debt, which together with the cost of equity makes up the weighted average cost of capital.

As long as ROIC is way higher than the weighted average cost of capital, it's fine. The business will keep on performing well. In a while, I'm going to show you 3 stocks that I think fit these criteria.

Number #3

The other reason is that high inflation — especially high gas prices & oil prices suggests that consumers have got less money to buy other stuff. So high inflation causes lower purchasing power and demand destruction, which means consumers now can't spend as much, and 70 of GDP comes from consumer spending. So that could tip the economy into a recession if oil prices keep going up.

So is this bad for companies, is this bad for stocks?

Yes, of course,  because if people buy fewer goods and services, stock sales & profits will fall, and the stock price will fall.

So we want to own stocks that are essential to consumers and businesses. In other words, we want to own companies that are as recession-proof as possible, so even if there is a recession people would still buy them.

So what are the essential products that people have to spend on?

Healthcare. Like it or not, if you're sick, you have to spend on your medical prosthetic arm, you have to spend on medicine. That's why a big part of my portfolio is in healthcare businesses. Now if you ask my wife what's essential to her, she'd say makeup, skincare, and lipstick! So even if times are bad, women would still spend on their faces, and some men would do so as well. So look at businesses like Estee Lauder.

I'm a professional investor, so I spend a lot of money on research tools and one of the websites I subscribe to is the S&P Global, which is SPGI. Fund management companies and banks have to spend on research, so a company like SPGI in a way is essential. People still have to use their services even during tough times.

The Only Way To Beat Inflation

So let's summarize everything which I've said so far.

Inflation is high and it'll continue to be high for quite a while, and if we hold cash we are going to guarantee that our wealth will fall.

So the only way to beat inflation is to own productive assets like real estate and businesses. When we buy stocks, we are essentially buying pieces of businesses.

Again, in the short term, stocks could fall more than 8% because the market freaks out, but over time in the next 1-5 years, I can guarantee you that stocks/businesses will outperform holding cash.

How To Beat The S&P 500

Right now if you just hold the index — the S&P 500, it's good enough. You'll do really well.

But if you want to beat the S&P 500, to get even higher returns than the S&P 500, then you'd want to hold businesses that have the following characteristics:

Number #1: We want to own businesses that have high pricing power. So these are essentially brand monopolies that are able to raise prices to pass on the cost to their consumers.

Number #2:  We want to own businesses or stocks that require low capital expenditure to maintain their current operations. So we don't like businesses like airlines, auto manufacturers, or construction companies that have to keep spending on more plant machinery and equipment to just maintain their cost efficiencies.

Now some people would ask me about Amazon. I said I like Amazon but Amazon spends a lot on CAPEX. The difference is that Amazon spends a lot on CAPEX for future growth, not to maintain current operations.

So in other words, Amazon has a choice to cut their CAPEX if they wanted to, but other companies don't have the choice. They have to spend on CAPEX to maintain their business operations.

Number #3: We only want to own businesses that are making money right now, that are generating tons of free cash flow, and their cash flow is increasing year after year.

Number #4: We want to ensure that the business has a high return on invested capital. Return on capital is the best way to tell if the company's stock is going to beat the market over time. As long as the return on capital is greater than the weighted average cost of capital, which includes the cost of debt, then the business would be very very successful. So we want the ROIC to be way higher than the WACC.

Number #5: With high inflation, consumers now have less money to spend, or rather they have got the same money but their money buys less stuff. So now they have to choose what to buy after paying for gas. So we want to own businesses that are as essential as possible to consumers where consumers say you know "I have to buy this", like makeup or healthcare, stuff like that.

These are the companies that will do well even if we get into a recession.

So let me just show you 3 businesses that I believe meet my criteria and a disclaimer; I do own these three businesses and I've been buying them consistently. I'm using the GuruFocus website to show the data because I think they've got great features on their website, so I don't get anything from them. I'm just sharing it because I use it every single day.

Stock #1: S&P Global Inc (SPGI)

So the first business which I own and which I've been adding is the S&P Global Inc. (ticker symbol SPGI).

Now does it sound familiar?

So they own the S&P brand, so any ETF, any index that uses S&P has to pay them a franchise fee or royalty.

S&P, like Moody's, gives ratings to bonds. They do all these financial ratings and they also offer a lot of research data.

So for example I personally subscribe to S&P, and all the professional fund managers & banks, they all have to subscribe to S&P as well, so it's almost an essential service that we have to use. We have no choice, we've got to use them.

Number #1: They have pricing power. They can raise their price whatever they want, we have to pay the price because it's like a freaking monopoly.

Number #2: They have got little or no capital expenditure.

Number #3: They're making money right now. It's a cash-generating machine. If you take a look at their revenue, you can see that their revenue consistently grows almost every single year and it's almost recession-proof. The last recession was in 2020, and their sales increased during the recession — their profits increased during the recession. So we want companies that are more or less recession-proof like that.

Take a look at their free cash flow & operating cash flow — again, they're generating free cash flow every single year so these are other companies that will do well. So you've got to only focus on these solid kinds of companies.

Number #4: The other thing which I talked about is that I only like to invest in businesses with a high return on equity, the return on capital. So one way is to look at the ROE as well as the ROIC. The current ROIC for this company is 33.74%. What this means is that for every $100 that the company invests in capital, it makes $33 in profits. That's extremely good, so we want companies with ROIC as high as possible, preferably above 12%.

In the long run, what has been found is that stock price performance tends to correlate to a company's return on capital. So in other words, if a company can return 30% on capital, its stock price would return 30% over the long run. That's why ROIC is really important.

Now we talked about the cost of debt as well. When a company borrows money there's a cost of debt and a cost of equity. Together, it's called the weighted average cost of capital. So we want to make sure that the businesses that we buy, their ROIC is much bigger than the cost of capital — so in other words, if you look at SPGI, their return on capital is 33% and the cost of capital or WACC is 7.5%.

So this company makes a lot more money than the cost of its debt & equity and that's how its share prices are able to beat the market over the long run.

Stock #2: Johnson & Johnson (JNJ)

Another example is  Johnson & Johnson. We have to use healthcare medical in any circumstances.

Does it have pricing power?

Yes, it's a brand where they can raise prices. They've got low CAPEX to maintain current operations. They've got all these patents that they own, and they are profitable right now.

So if you look at their revenue, you can see that revenue is growing consistently. Even during the recession, it's still growing, so again, it's essentially recession-proof. Profits are growing consistently and the company is a cash-generating monster.

Free cash flow is increasing every single year, together with operating cash flow. The return on invested capital (ROIC) is way above the weighted average cost of capital (WACC), and for Johnson & Johnson, the ROIC is currently at 17.43%, which is extremely profitable as well.

Stock #3: Microsoft (MSFT)

So a third example is one of my favorites which I own in my portfolio as well; Microsoft.

Needless to say, Microsoft definitely does have pricing power. It can raise prices and people will still use their services. It's essentially recession-proof.

People have to keep subscribing to their software from the office or from home, and again revenue is increasing consistently, profits increasing consistently, and cash flow is going up consistently.

They have got a lot more cash than debt and their weighted average cost of capital is very low, so the cost of borrowing money is very low for them, and their return on invested capital is over 30% as well.

So these are just 3 of the great businesses that will beat inflation and beat the market over the long run that is in my portfolio.

There are many more companies such as these 3 out there.

If you don't know how to research these companies — how to value these companies, then you got to take the Value Momentum Investing™ Course, or better still, subscribe to the Ultimate Investors Playbook™ where I do all the research for you, and you'll know exactly what are the companies to own that's going to build your wealth over the long run.

Now some people would say "But Adam haven't you been listening? We are in a bear market right — a recession is coming and you want to buy stocks? Are you nuts?!"

Now I'm going to talk about that in my next video, about this bear market that everyone's talking about, and about this recession.

Is it happening? Is it going to happen, and is this a time to own stocks?

Am I saying that it can't go lower? No, it could still go lower, no one can predict the bottom exactly because there are too many moving parts and variables.

But what I'm saying is this; if you own good companies over time, 1 year from now, 5 years from now, it will beat inflation. You'll beat holding cash and it will grow your wealth.

What If We Enter a STAGFLATION?

Now finally, let me address this question people have been asking me about:

What if inflation keeps going up and we go into recession, and it's called stagflation — what happens then? Do we still want to own stocks in a stagflation environment?

Yes, we do.

Let's take a look at the last time this happened which was stagflation where inflation went up to 12% in the U.S. and then up 15% — and there was the time when the FED had to raise interest rates to 12% and 20%, so you can't get worse than this. This is the 'nightmare doomsday' scenario.

So what happens if this scenario plays out?

Well, you'll see that it's still good to hold stocks and it's the best thing to hold even in this doomsday scenario.

Why?

During this period, which was from 1970 to 1980, which was severe inflation, the economy went into recession (we call that stagflation), if you held the S&P 500 and reinvested dividends, your total return during those 10 years will be 130% not bad for a doomsday scenario.

If you analyze it, it's a 7.89% return a year on average.

So this is the S&P 500 with dividends being reinvested. So you can see that if you invested $100 in the S&P 500 at the beginning of 1970, at the end of 1980 you would have $230.60 this is a return on investment of 130% or roughly 7.89% a year.

This is only if you put everything in one lump sum at the start of 1970. If you did Dollar-Cost Averaging which means you bought in consistently every month, you would have grown to $223.37 dollars, which is slightly less but still a pretty good return.

Now, this investment result beats inflation by about 8.5% for the 10 years right, or about 0.75% per year.

That is on top of inflation, so in other words what I'm saying is this; If you're like most people who are so scared you do not dare to invest, you just hold cash during this doomsday period, you get 0% per year, while inflation is 7% a year.

So every year that you hold cash, you're losing 7% in purchasing power, but if you hold the S&P blindly, just holding it through the ups and downs and ignoring the short-term drops, you're getting 7.89% per year. It's not that much greater but at least you're beating inflation by 0.75%.

At least you're maintaining your wealth and not losing your wealth, and that's why I keep saying that in the long run, the best hedge against inflation is owning productive assets, be it real estate — you could own REITS as well — or by owning businesses through the stock market.

Hope it's been useful and I'll see you guys next time when I'll be talking about the so-called bear market and the so-called inevitable recession coming up! 

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