Investors, including the seasoned ones, can never accurately predict where the stock market will turn next. Bull markets can end in a wink of an eye because of unforeseen catastrophic events. While some risks are evident and likely to cause a correction, Warren Buffett knows one hidden risk. He fondly refers to it as the market bogeyman.
A crash factor
U.S. Federal Reserve Chief Jerome Powell warned of high inflation in 2021. Inflation is the classic crash factor for legendary investor Buffett. The GOAT of investing has lived through recessionary environments with the worst inflation ever. In the most recent Federal Open Market Committee (FOMC) meeting in the U.S., Powell raised the inflation topic.
The U.S. central bank head said, “Frankly, we welcome slightly higher, somewhat higher inflation.” He adds, “The kind of troubling inflation people like me grew up with seems unlikely in the domestic and global context we’ve been in for some time.”
How to counter the hidden risk
Buffett said in May 1977 that inflation swindles stock investors. He wrote that stocks, like bonds, perform poorly in an inflationary environment even if conventional wisdom says they serve as a hedge. From the late 70s to early 80s, significant portions of Buffett’s letters to Berkshire Hathaway shareholders focus on inflation.
The Oracle of Omaha knows perfectly well that too much inflation can ding stocks. Also, exploding inflation is the biggest risk to the economy. He does not recommend to stock investors to head for the exits. Instead, he offers advice on how to deal with this hidden risk.
When inflation intensifies, more and more companies see the need to spend all internally-generated funds to maintain existing business volume. In a high inflation scenario, Buffett usually focuses on companies that generate rather than consume cash. He also looks for businesses that can increase prices while keeping expenses in check.
High inflation can eat on your savings and disrupt income streams. Stock investors can tame inflation by investing in growth-oriented companies. Absolute Software (TSX:ABT) is an excellent choice. Apart from the 1.82% dividend, the potential for capital growth is fantastic.
The $864.8 million American-Canadian firm specializes in endpoint security and data risk management. Cybersecurity is also a real need in today’s business environment as networks are vulnerable to malicious hackers’ breaches and attacks. Every major PC manufacturer installs Absolute’s endpoint security solution.
Absolute enables the essential security tools (anti-virus, and VPN, among others) of platform users to self-heal, repair, or reinstall automatically disabled, altered, or made vulnerable.
In fiscal 2020, the company reported a record annual revenue of US$104.7 million, a 6% increase versus fiscal 2019. Absolute’s net income was US$10.6 million, which represents a 40% growth over the previous fiscal year. Furthermore, it recorded double-digit growth in annual recurring revenue (ARR).
The company projects revenue growth in 2021 to be between 7% and 13% (US$112 million to US$118 million). Cash from operating activities should be around 22% to 34% of revenue, while capital expenditures will not exceed US$4.0 million.
Adapt Warren Buffett’s move during an inflationary environment. Invest in companies with the ability to increase prices relatively easily even when product demand is flat, or capacity is under-utilized. There should be no significant loss of market share or business volume.
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Fool contributor Christopher Liew has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and recommends the following options: short January 2023 $200 puts on Berkshire Hathaway (B shares), short March 2021 $225 calls on Berkshire Hathaway (B shares), and long January 2023 $200 calls on Berkshire Hathaway (B shares).