Investing in the stock market is about supercharging your wealth. Part of that equation is buying companies that are growing much faster than the economy. The other part is about protecting yourself against market shocks and obtaining income in the short term. Put another way, investing in ASX stocks is about managing risk to build wealth, which is where the combination of Under the Radar Report and Blue Chip Value is invaluable.

How will inflation affect investing?

We have a value bias because it offers that protection and gives us access to growth stocks. I have spoken recently about the market factoring in the chance of the inflation genie escaping from the bottle. There are valid concerns about this in the US. Although they should not be overstated, there are initial signs indicating that the Federal Reserve maintaining near-zero interest rates and US$120bn of bond purchases a month are having an impact.

The timing of rising inflation might be up in the air, but what isn’t is a growing concern, which will ebb and flow as data hits investor shores. This is already ushering in a period of heightened uncertainty and volatility. In this environment, investors will gravitate to stocks that pay consistent dividends and return capital to investors because of the certainty this offers.

Investing in stocks that have strong balance sheets

Dividends are only part of the story. What is more important for protection, is investing in stocks that have strong balance sheets. In the past two crises – the financial crisis of 2009-11 and the 2020 pandemic – it has been clear that investors attach big premiums to companies whose valuations are underpinned by balance sheet strength.

We are close enough to those events that many CEOs are very conservative when it comes to capital structure. We have spoken about this in relation to the big banks, which have become fortresses in the past few years. NAB, CBA, ANZ, and WBC have all increased their capital adequacy to world-leading levels, enabling Australians to get through the pandemic. Similarly, in light of collapsing commodity prices in 2011, resource companies like BHP and Rio Tinto (RIO) are much more focused on maintaining a strong balance sheet.

Australia's defensive edge

Stocks, or equities as an asset class give better returns than bonds or property because of competition for capital. In Australia, there is the added and important benefit that domestic earnings are treated preferentially by the tax office. Investors here get imputation or franking credits.

In the US almost 100% of the return from investing in stocks comes from growth. In Australia, a greater proportion comes from dividends because of their tax effectiveness. This imparts a more defensive stance among both companies and investors, which is of great importance during periods of heightened uncertainty.

After all, it needs to be remembered that shareholders are at the bottom of the investment queue, ranking behind all forms of debt, creditors, and employees. If there are residual cash profits after these people have been paid, the company has the discretion of whether or not to pay out part of this to shareholders.

Why stocks actually benefit from inflation

Inflation does represent a risk, but it’s more of a risk for fixed-interest securities such as bonds and term deposits because they pay very low rates of interest. Rental yields too are currently at historic lows and the property sector is highly indebted.

Companies on the other hand are able to keep up with the economy because they are the economy! When prices rise it’s because companies are putting them up! Sure, they must sustain some increase in their own costs, but these costs are much more fixed than revenues, which is why you get operating leverage (a faster rate of profit increase for every additional dollar in sales).

Under the Radar Report is managing your risk

There is a risk, but as I said, we are managing that risk for you by advocating stocks that have strong cash flow, strong balance sheets and can pay dividends regularly through the cycle.

Buying Small Cap stocks that are good value means your investments aren’t reliant on market sentiment about the future.

Start investing successfully in fast-growth ASX Small Caps now with Under the Radar Report.

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