Resilient stocks the pros are backing as inflation winners

We name the shares that professional investors argue are inflation-proof due to their ability to pass on price increases. 

Time will ultimately tell whether inflation has peaked following new prime minister Liz Truss’s intervention to cap energy bills for average use at £2,500 per year, for the next two years. 

In August, inflation eased slightly from 10.1% to 9.9%. However, it is still near its highest rate in four decades.

For some time, fund managers have been preparing for a period of sustained high inflation, with our article at the end of last year highlighting the various qualities that fund managers look for to find companies that can cope with and pass on price rises.

Inflation is a question we regularly ask fund managers – including on our Funds Fan podcast and in our Insider Interview video series.

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Below we name some resilient share examples the pros are backing at a time when inflation remains near its highest level in decades.

Income picks

Job Curtis, fund manager of City of London (LSE:CTY) investment trust, points out that with inflation at high levels there’s a greater appreciation for dividends.

In a video interview with interactive investor last month, he named British American Tobacco (LSE:BATS) and M&G (LSE:MNG) as two of the highest yielding shares he owns whose dividends look sustainable despite inflation being at high levels. The respective yields are 6.2% and 9%. The trust, which has raised dividends for 56 consecutive years, is a member of interactive investor’s Super 60 list.

Curtis said: “Over the very long run, dividends pay a very important part of the total return. People forget about it, and get much more obsessed with how much shares go up.

“But in terms of the total return, given in periods when shares go down, the actual dividend pays a very important part. I think people have noticed it more this year because it's been a different type of market, it hasn't been led by the growth stocks.”

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Mark Peden, manager of the Aegon Global Equity Income fund, points out that dividends have a good track record of keeping pace with inflation.

He added: “Dividend strategies, by nature, invest in more established companies that generate lots of free cash flow and tend to fare better in a slowing growth or recessionary environment than more growth-focused companies that need to invest for that growth.

“They also tend to be more defensive options, meaning they tend to fall less than the market in down periods. This is important in the current, volatile conditions.”

When looking at how to invest in reliable dividend-paying firms, Peden says the quality companies are those that generate consistent returns and have strong balance sheets.

He also highlighted firms with long dividend track records – so-called ‘dividend kings’ – which have increased payouts for more than 50 years. Peden named Johnson & Johnson (NYSE:JNJ), Cincinnati Financial (NASDAQ:CINF), PepsiCo (NASDAQ:PEP) and Nucor (NYSE:NUE), as four examples that have achieved this feat.

With such companies, Peden notes the dividend is clearly highly regarded, and management teams will not want to see those track records end. 

However, the strategy is not bulletproof, as Shell's (LSE:SHEL) dividend cut a couple of years ago proved. The company had previously not cut its dividends since the end of the Second World War.

Searching for pricing power

Companies possessing pricing power is widely viewed as a key ingredient to find shares that have the ability to pass on increases in the cost of living.

In a video interview with interactive investor earlier this year, Simon Brazier, fund manager of Ninety One UK Alpha, a member of interactive investor’s Super 60 list of rated funds, picked out Reckitt Benckiser (LSE:RKT) and Unilever (LSE:ULVR) as two examples that have pricing power.

He also named aggregates and construction materials groups SigmaRoc (LSE:SRC), Breedon Group (LSE:BREE) and CRH (LSE:CRH), as companies that have pricing power.  He said: “These are companies that are able to push that pricing through onto their customers because they're typically local markets and they have pricing power, so that's what we're trying to find in this type of environment.”

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For Bruce Stout, fund manager of Murray International (LSE:MYI), also in interactive investor’s Super 60 list, the ability to pass on prices comes from companies “having something tangible”. In a video interview with interactive investor earlier this year he named Canadian pipeline businesses Enbridge (NYSE:ENB) and TC Energy (TSE:TRP), as well as Telecom Indonesia, as examples of companies that can navigate high levels of inflation.

Stout made the point the two pipeline firms “can push through prices if gas prices go up”, while Telecom Indonesia’s dominance in its market means “if they need to put up prices, then they should be able to do it because they're in a kind of monopoly type position.”

He added: “Real assets in an inflationary environment really just means that you've got something tangible that hopefully you can pass pricing through with.”

Pricing power is one of the attributes that Alliance Trust’s external fund managers have been seeking.

Craig Baker, global chief investment officer at Willis Towers Watson, who manage Alliance Trust (LSE:ATST), noted that he had been challenging the stock pickers he oversees on inflation.

He said: “In the environment of high inflation we’ve been asking the fund managers what this means for the companies they have selected. Inflation risk can negatively impact corporate growth and margins. Our stock pickers look for stocks that can weather a variety of market environments including inflation.”

Baker named TransDigm Group (NYSE:TDG) as an example of firm with pricing power. It provides thousands of niche-piece part components for use on commercial and military aircraft. Baker pointed out it is an example of a "mission critical company."

Other resilient stocks held by Alliance Trust include Intuit (NASDAQ:INTU), on the grounds it has low capital intensity; Visa (NYSE:V), due to its transaction-based revenue; and Salesforce (NYSE:CRM), which holds a dominate position in its market.