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Inflation has skyrocketed across the globe since late 2021, with the UK currently experiencing an 11.1% price average rise (a 40-year high). This has put pressure on many companies’ profits as they contend with more frugal customer bases and higher input costs. Yet the good news for investors is that it is still possible to find companies which perform strongly during times of high inflation. Below, our team at Bure Valley Group offers ideas to help investors find opportunities like this. We hope you find this content useful. To find out more about our EIS projects and other investment opportunities, visit our portfolio page here. To enquire regarding our latest projects and funding, you can reach us via:
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#1 Staple-offering companies
When times are hard in the economy, households are likely to cut back on discretionary items and focus on the “must haves”. This is partly why Netflix has suffered declines in revenues over recent months, as people cancel their subscriptions to focus their budgets more on essentials. Yet people will always need staple food items (e.g. milk), household goods (e.g. toilet paper) and key services like pest control, electrical repair and plumbing. Companies which make such goods and services easier, faster and cheaper to access stand a better chance of faring well in a downturn or high-inflation environment.
#2 Strong pricing power
When inflation is in the double-digits, companies will be in a stronger position if they can raise prices without causing customer flight. If a good or service is deemed “essential”, is low in cost and difficult to find in other places, then customers will likely stay (even if begrudgingly). An early-stage company or startup may struggle here, since they still need to prove their concept to the market. Yet it is possible. For instance, a new SaaS company (software as a service) might achieve this by embedding its product(s) deeply into the systems and processes of B2B customers, making it difficult to switch elsewhere.
Another approach is for a company to have such a powerful brand that the above three factors are made almost irrelevant. However, this route will be very difficult for early-stage companies to accomplish since they may not have yet built up a loyal customer base.
#3 Low-intensive capital
The more a business can grow without tying up significant capital. Airlines are perhaps one of the worst examples here, since they need to expand their fleets, staffing and fuel consumption to grow. Yet early-stage companies are often in a strong position here. For instance, a specialist price comparison site might generate most of its profits via digital channels (e.g a website) and could expand its business by increasing its search engine presence. Such expansion may not even require hiring large numbers of extra employees.
#4 Scalability
Some companies gain greater efficiency as they grow in size. Economies of scale reduce the per-unit fixed cost. Moreover, larger companies can often command lower prices from suppliers, giving them an advantage in high-inflation environments. By nature, of course, early-stage companies do not boast great size. However, they can still benefit from economies of scale. For instance, a delivery app might reduce the time drivers spend delivering items to customers as the company grows its customer base within different localities.
#5 Strong margins
Consider two toy companies. The first earns operating margins of 15% and the second 5%. If costs rise in the sector by, say, 10% then the former’s profitability would fall by a fifth. The latter, however, would experience far greater loss. Companies which succeed in maintaining high profit margins, therefore, often perform better during high inflation. The challenge for early-stage companies, of course, is that most are still establishing profitability in their early years. Yet an investor can take courage from founders who focus on profit margins before revenue growth. A startup with a strong culture of driving down input costs – e.g. through increasing efficiencies in warehousing, automation and logistics – will stand it in good stead even if it is still getting onto its feet.
Final thoughts for early-stage investors
Investors may be asking whether their portfolio strategy should change in light of the current high UK inflation context. As a general rule, early-stage investors should always be looking for businesses that can withstand different negative scenarios in the economy. If these then come to pass, therefore, the investor can take more confidence that their chosen investments have a strong chance of weathering the storm. If these do not occur, however, then the investor has even more reason to hope for the best.
Invitation
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