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In the previous Wealth Preserver column we added the first four of eight stocks to the portfolio (they were Dixons Carphone, WH Smith, Admiral and RWS). Today we introduce the other four. As before, we aim for businesses that should be able to raise their prices in inflationary times. Our portfolio will allocate 2.5pc of its money to each stock.
First is Diageo, the spirits company. As a supplier of premium products desired over the generations and over the world it is in a strong position to raise prices should its own costs, such as its workers’ wages, rise. We lauded its “quality” credentials – high returns on capital and strong cash generation – when we tipped the stock almost four years ago but reported the uneasiness felt by Nick Train of Lindsell Train, a leading investor in the firm, over some of its capital allocation decisions.
However, Diageo remains the largest holding in Train’s Finsbury Growth & Income investment trust and he said earlier this year that the company was well placed to benefit from “any possible roaring Twenties”.
He noted that consumers across the world were drinking less alcohol by volume but were choosing more expensive drinks, such as those made by Diageo. He said this was especially true in emerging economies in Asia, where premium beverage companies were acting as a “proxy for wealth creation”.
Auto Trader is another “quality” company: the car sales website’s returns on capital are more than 50pc and it turns 95pc of its profits into cash, we reported when we tipped it in February. We added that its market share was seven times greater than that of its closest rival. This is the kind of dominance that should allow it to increase prices if it needs to – if it needs to increase its employees’ salaries, for example.
The company may well be one to enjoy a short-term boost as households finally spend money they saved during lockdowns but longer-term developments are in its favour too: the switch to electric cars is gathering pace and the effects will spill over into the second-hand car market.
Then there is the fact that people are becoming increasingly comfortable buying even big, expensive things such as cars online. It’s a well managed company that deserves its premium valuation of about 28 times forecast earnings.
Our last two stocks were tipped for the wider readership, though with a nod to their inflation-beating credentials, on Wednesday. Spirax‑Sarco, the specialist in steam engineering, is another market leader – in fact no competitor rivals its worldwide team of specialist engineers, which allows it to foster direct relationships with its clients. Price is less important than quality and reliability to those clients, so Spirax-Sarco should cope well with a return of inflation.
Smart Metering Systems, meanwhile, owns smart meters and rents them to utility companies in exchange for an index-linked annual sum.
Now it’s common for businesses to say they have index-linked revenues but it is worthwhile digging a bit deeper and checking the detail. Some inflation-linked contracts turn out to have caveats – caveats that could render the companies involved virtually useless as inflation-proofing investments should the cost of living really get out of control.
Questor has come across some property companies, for example, whose contracts with tenants specify that rents will rise in line with the consumer or retail prices index – but only up to a maximum of 4pc. This portfolio is intended to cope with inflation of 20pc or even 30pc, the kind of levels seen in the 1970s, so an inflation link that was broken as soon as the index reached 4pc would be virtually useless.
Happily, there are no such constraints on Smart Metering Systems’ contracts with its customers: the inflation link is uncapped, the company confirmed to this column yesterday. If we were to see deflation, an eventuality that our portfolio is also designed to cope with, we are still well placed as there is a clause to say that SMS’s rents cannot fall even if the cost of living does.
Questor says: buy
Tickers: DGE, AUTO, SPX, SMS
Share prices at close: £34.34, 635.4p, £139.10, 880p
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