So i was doing some research on inflation and i came across this sentence, "The impact of inflation on your portfolio depends on the type of securities you hold. If you invest only in stocks, worrying about inflation shouldn't keep you up at night since historically stocks have been quite good hedges against inflation." from https://www.investopedia.com/university/inflation/inflation4.asp at the start of the 2nd paragraph. Can someone please explain why is that?
Inflation is a decline in the value of money, but companies can generally adjust their prices to account for that decline.
Take a simple example. Say company X is producing widgets that sell for $100, and makes $10 profit on each one (which it pays to shareholders as dividends). Now you have 10% inflation, so the company changes the price to $110 and makes $11 profit, which is exactly the same after adjusting for inflation. Thus the value of the company in real terms hasn't changed.
One has to keep in mind that companies have already invested in buildings, factories, vehicles, real estate, other equipment and other assets. As inflation increases, the value of assets that they already own may become more valuable because they would be more expensive to replace. This may make a barrier to entry for competitors to start a competing business because they would have to purchase these assets at a higher price.
However, there is another side to the same coin. Often, central banks respond to inflation by raising interest rates. When this happens, the cost to borrow money increases, which increases businesses expenses. If customer's wages are not rising at the same rate as inflation, companies may find that if they raise prices, customers may not buy as much. Therefore, they may not be able to fully absorb higher costs. This might be a factor that decreases the value of a company.
Another thing happens when central banks raise interest rates. If they do, this might be reflected in the value of bonds. Bond interest rates are likely to rise (dropping the value of existing bonds). This may make bonds relatively more attractive than stocks with the result that people sell stocks and buy bonds instead. This would tend to push prices for stocks down.
Therefore, "inflation" may either increase a company's value or decrease it depending on which factors are most influential. So, even though some companies may become more valuable when inflation increases, others may become less valuable.
We are going through a high rate of inflation today. The Federal reserve has responded with interest rate hikes and the overall stock market has dropped as a result. Therefore, at least as of December of 2022, the factor of rising borrowing costs along with consumer
incomes that are rising less quickly than inflation appears to have dropped the value of stocks.