Jeff Reeves’s Strength in Numbers: Invest in these 5 high-margin stocks to beat the specter of worrisome inflation

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Amid all the attention being paid to the strong U.S. economy, many investors are looking over their shoulder and wondering when resultant inflation will finally catch up with us.

Inflation this summer hit its highest level since 2012. Though the August CPI report, released a few weeks ago, showed a drop in the pace of the annual increase to 2.7% from 2.9%, the monthly gain was the fifth consecutive increase in the closely-watched price index.

So far, the S&P 500 index SPX, -0.55%  has shrugged off any inflationary pressures. Yes, we are still on the low end of historical price pressures; as recently as 1990, inflation topped a 6% annual rate in a handful of monthly readings. But anyone who has seen the damage that inflation can do to the economy — or to their portfolio — knows that by the time inflation is clearly visible, it may be too late.

That’s why it may be wise to start thinking proactively about investments that can hang tough, even amid rising prices.

The following five stocks all can do exactly that. They boast above-average margins, both compared with their peers and the market in general. The gross margin for S&P 500 components averages 48% across the trailing 12 months, according to financial data site CSIMarket; a recent Goldman Sachs note pegged the typical gross margin at 44% by filtering out financials, real estate and utilities in the Russell 1000 RUI, -0.58%

Margins at these five companies are holding firm at these levels, or have materially improving in recent quarters. That shows momentum is in the right direction, which will help defend prices even if input costs rise.

Also, each of these stocks has soft power via a connection to their brand and products that will help fend off competitors who may undercut prices.

If you’re worried about rising prices, think of these five stocks as your way to fight inflation in the years ahead.

Coca-Cola

When it comes to brand, it’s hard to pick a company that’s more powerful than the Coca-Cola Co. KO, +0.07% For fans of the soft drink, switching to store-brand cola instead of this company’s namesake beverage is simply not an alternative.

Admittedly, Coke has had some trouble in recent years as consumer tastes generally have skewed toward fresh and healthy offerings instead of soda. The stock has underperformed significantly, with returns of just 22% in the last five years against gains of more than 70% for the S&P 500.

However, now is a great time to consider buying into Coca-Cola stock as a hedge on inflation. As proof of its brand power, the company has pricing power with excellent gross margins of 63.8% in its most recent quarter. That’s actually up significantly from 62.3% a year ago.

There admittedly may not be amazing growth here given recent trends in the grocery aisles. But this is a company that’s not going anywhere and is an excellent defensive play if you’re worried about inflation. A great brand and great margins are backed up with over $15 billion in cash and short-term investments, and roughly a century of dividends with at least one annual increase in those payouts for each of the last 55 years.

Cadence

Though not a household name, Cadence Design Systems Inc. CDNS, -1.20% is highly respected within its niche of designing automation software for tech hardware, including semiconductors and circuit boards. As specifications for chips become ever more precise, many of these designs couldn’t become reality without Cadence.

Cadence has been on a great run, surging more than 200% in the last five years thanks to strong profit growth — and a big reason for that growth is its amazing margins. It had a roughly 88% gross margin last quarter based on its reported cost of services, products and maintenance! Of course, Cadence plows a lot into R&D and marketing, but it can clearly afford to do that based on this level of profitability.

This midsize company isn’t on the radar of many investors, but this $12 billion market-cap firm is consistently increasing sales and earnings. Furthermore, as a software company that services chip makers, it is largely insulated from the ups and downs of actual hardware sales and shouldn’t be as exposed to pricing or demand pressures.

Zoetis

Animal health giant Zoetis Inc. ZTS, +0.97%  was spun out of Big Pharma icon Pfizer Inc. PFE, +0.47% in 2012 to let it focus on medicine and vaccines for pets and livestock. From a shareholder perspective, that move has certainly paid off in a big way, as Zoetis stock is up almost 200% in the last five years. Pfizer has slightly underperformed the S&P 500 in the same period with just 50% returns or so.

A big reason is Zoetis’ strong margins, which tallied 79.3% domestically last quarter and 68.5% internationally, up from 68.5% and 65.5% respectively the prior year.

Though targeted on a niche, the same rules apply to Zoetis that apply to many familiar health-care stocks: Pet owners and farmers will forgo many things in their day-to-day expenses before they opt out of the medicines that keep their animals healthy. That not only allows for these juicy margins, but provides stability for the stock if broader economic pressures cause a pullback in spending on more discretionary areas of the economy.

Adding to its stability, Zoetis boasts deep pockets, with $1.5 billion in cash and equivalents on the books.

PVH

PVH Corp. PVH, -0.93%  is the apparel giant behind the Calvin Klein and Tommy Hilfiger brands, among others. High-end products and strong brands allow PVH to command top dollar for its goods, and it shows in the company’s margins: Gross profit margins tallied 55.6% in PVH’s most recent quarter, well above market norms and up slightly from 55.4% the prior year.

And unlike many apparel companies that rely on bricks-and-mortar operations to sell their wares, distribution and licensing deals have insulated PVH from many of the pressures brought on by e-commerce. But even with limited store operations, PVH is seeing momentum. Its Calvin Klein North America segment saw 19% year-over-year overall growth in the second quarter, and 2% comparable-store sales increase when you back out wholesaling. Similarly, its Tommy Hilfiger North America segment saw a 9% overall increase and a 5% increase in comps at its modest group of Hilfiger-branded stores.

When you have a powerful nameplates that command premium pricing, it’s much easier to fend off the pressures of inflation or rising input costs.

Fortive

When most investors think of chasing margins, they probably don’t spend much time exploring industrials. But Fortive Corp. FTV, +0.04%  has enviable profit margins not just compared with its peers, but compared with the typical S&P 500 company.

Specifically, Fortive reported second-quarter gross profit margin of 50.6%, up from 49.4% the prior year, attributing the increase to both cost saving as well as higher sales volume.

Though it is a bit of an odd man out on this list as an industrial company, a closer look shows Fortive does share some of the same strengths as the other picks. Born out of the Danaher DHR, -0.02%  after a 2016 spinoff, Fortive is a highly specialized testing, measurement and robotics company that helps keep infrastructure working and manufacturers operating at their best.

That makes it almost a form of utility for many businesses and thus a must-have line item. This necessity allows Fortive to command premium pricing, and provides a measure of stability for shareholders.

Since debuting as a stand-alone company a little more than two years ago, Fortive stock has gained roughly 70% compared with about 40% for the S&P 500.