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Profit From Inflation: These Six Stocks That Will Add Punch to Your Portfolio

If there's one skill you need to learn, it's how to profit from inflation.

Thanks to the cheap-money policies of Team Bernanke at the U.S. Federal Reserve, the escalating levels of global sovereign debt, and other recent developments in the world economy, it's clear that we're headed for a period of steeply rising prices – inflation. If you know how to navigate this tricky stretch, you'll be fine. But those who don't are going to really feel the squeeze.

Learning how to profit from inflation is actually an easier assignment than you might expect. First, you have to invest in certain classes of stocks that have historically performed exceptionally well when inflation has raged across the land. And, second, you will enjoy maximum profits if you invest in those stocks before inflation really takes hold.

Let me use six specific stocks as examples to show you what I mean.

How to Profit From Inflation: Consider These Stocks

Commodity players and natural-resources companies are great candidates for a "how to profit from inflation" strategy. That's because their sales and earnings increase when the prices of the underlying commodities they deal in rise.

Finding other possible inflationary beneficiaries can be more of a challenge. Developers of new products and technologies that catch the market's eye will certainly produce gains that outpace inflation – as will firms that benefit from government actions intended to fight rising prices.

Other potential gainers can be found among the ranks of companies that can raise prices in line with – or, better still, faster than – the rate of inflation. Companies that can do that can maintain a rate of profit growth that exceeds the rate of inflation.

You should also look for companies that can increase their dividends at a rate faster than inflation, since that gives investors a real-dollar profit. Good candidates in this area include real estate investment trusts (REITs), which have relatively stable costs and have borrowed money at current low rates, but will collect higher payments as inflation pushes up rents and lease rates.

Using these guidelines to help us, we've created a list of six candidates – and one bonus pick.

The six stocks in question consist of:

  • LSB Industries Inc. (NYSE: LXU).
  • Monsanto Company (NYSE: MON).
  • Fluor Corp. (NYSE: FLR).
  • Freeport McMoRan Copper & Gold Inc. (NYSE: FCX).
  • Safeway Inc. (NYSE: SWY).
  • Applied Materials Inc. (Nasdaq: AMAT).

Here's an in-depth look at the Money Morning inflationary pick-six:

  • LSB Industries Inc. (NYSE: LXU), recent price $42.92 – When food and agricultural commodity prices rise, farmers typically want to put more land into production – and get better yields from land they're already planting. That means greater use of fertilizers and other agricultural chemicals, as well as more irrigation, which might not have been profitable at lower crop prices.

    Both of those trends bode well for LSB Industries, a leading manufacturer of both agricultural chemicals and irrigation pumps. Through its subsidiary, ThermaClime Inc., it also stands to benefit from other firms' energy cost-cutting measures since it's a major maker of climate-control pumps, valves and other equipment for air conditioning, heating and ventilation systems.

    The company reported earnings per share of $1.14 for the year ending December 2010, but those numbers are expected to rise to $2.06 this year, spurred by a report of 88 cents profit in the first quarter and projections of a second-quarter sales increase of 142%. That estimate was bolstered by a June 29 report showing LSB ranks No. 1 in earnings-per-share-growth in the diversified chemicals group. LSB Industries has a market cap approaching $1 billion, but the stock pays no dividend as yet.

  • Monsanto Co. (NYSE: MON), recent price $72.54 – Before fertilizer can make crops grow, you have to plant them – and St. Louis-based Monsanto is the world's preeminent seed producer. The company just reported fiscal third-quarter earnings of $680 million, or $1.26 per share, on revenue of $3.59 billion – well above analyst estimates of $1.10 per share on revenue of $3.36 billion. That sent the stock higher, putting it within striking distance of its 52-week high of $76.69.

However, that price is likely depressed relative to potential since the company has some non-business related problems. Because it's so dominant, Monsanto faces an ongoing antitrust probe by the U.S. Department of Justice. As the world's top producer of genetically engineered seeds, it's also the target of protests from many environmental activists, though it's difficult to argue with the increased output genetic engineering has produced. Even more genetic improvements will surely be needed to keep up with the world's burgeoning population growth.

Political issues aside, analysts predict the company will continue to gain market share through 2012, especially as a supplier of corn seed. Monsanto has a market cap of $38 billion, is widely traded with an average daily volume of 4.67 million shares, and the dividend of $1.12 represents a yield of 1.55%.

But investors, heed this warning: While inflation will be good for major seed producers like Monsanto, it will hurt those supplying the home lawn and gardening markets as consumers cut back. That spells potential trouble for The Scotts Miracle-Gro Co. (NYSE: SMG), which caters to both U.S. and foreign markets. The stock bucked the upward market trend last week, giving back earlier gains – and will likely retreat even further from its 52-week high of $60.62 should inflation and drought-induced watering restrictions in the South and Southwest cut into sales.

  • Fluor Corp. (NYSE: FLR), recent price $64.66 – As inflation weakens the dollar, the price of oil tends to climb – as evidenced by its performance over much of late 2010 and early 2011. When oil goes up, drilling becomes profitable in harder-to-reach and more marginal crude deposits as producers seek to cash in on higher prices. This increased crude production requires increased refining capacity, meaning bigger business for Fluor, which gets more than half of its $20.8 billion in annual revenue (for fiscal 2010) from big-ticket oil-related projects.

The company could also benefit from shifts away from nuclear power as a result of Japan's Fukushima Daiichi disaster since it's a major builder of power plants around the globe.

Fluor earned $1.98 a share in the year ended December 2010, and reported earnings of 78 cents in 2011's first quarter. Despite riding last week's market rally higher, Fluor's stock is still priced well below its 52-week high of $75.75. Its 48-cent dividend provides a yield of 0.75%.

  • Freeport McMoRan Copper & Gold Inc. (NYSE: FCX), recent price $52.90 – Unless you've been in a coma, you know about the gains in gold, silver and other metals over the past year. What's not as well publicized is that many metal-miners stocks haven't moved up nearly as much as the prices of the minerals they pull out of the ground. However, the recent pullback in gold and silver could provide a launching pad for both metals and mining stocks when renewed inflation comes along to ignite the rally.

That could send shares of Phoenix-based Freeport sharply higher since it's one of the world's biggest gold miners. It's diversified by major production in raw copper, prices for which will also climb due to both inflation and continued increases in industrial demand in China and the rest of Asia.

With trailing-12-month earnings of $5.13 a share, the company has a below-industry-average price/earnings ratio of just 10.30 and the stock stands well below the 52-week highs made when gold was at its peak. For a large-cap, equipment-intensive company, Freeport also has a relatively low level of debt – only about 15% of its $50 billion market cap. Freeport adjusts its dividend quarterly, but has paid out $1.30 a share over the past 12 months, equating to 2.45% yield at recent prices.

  • Safeway Inc. (NYSE: SWY), recent price $23.37 – People can give up a lot of things when prices soar, but they still have to eat. As a result, modest food inflation usually helps the bottom line for grocers, which should benefit California-based Safeway, a leading North American supermarket chain with more than 1,700 stores in the U.S. and Canada.

Company profits are already showing improvement ($1.68 in fiscal 2010) following a major cost-cutting campaign in 2009 and early 2010. The stock has also demonstrated recent technical strength, bouncing off major support near $22.50. The 56-cent dividend represents a yield of 2.4%.

  • Applied Materials Inc. (Nasdaq: AMAT), recent price $13.01 – Inflation means companies have to operate more efficiently to maintain profit margins without sharply hiking prices – and in many industries, computers are key to increasing efficiency. That's good for Applied Materials, a leading global supplier of microchip-manufacturing equipment, services and software to the semiconductor, flat-panel display, solar photovoltaic (PV) and related industries.

The company has a substantial operating margin – 23.65% in the second quarter of fiscal 2011, ended May 31 – and provided a 12.82% return on equity (ROE) in FY2010. It has more than $2.5 billion in cash and short-term liquid assets on its balance sheet, and just $204 million in debt – well below the average for its competitors. With trailing earnings of $1.19 a share, AMAT can easily cover its modest dividend of 32 cents, which provides a yield of 2.45%.

And as a bonus pick for those who'd like to get some China exposure along with their inflation gains, Yongye International Inc. (Nasdaq: YONG), recent price $5.25, fits the bill perfectly. It's a major researcher, developer and manufacturer of fertilizer (fulvic acid-based liquid and powder nutrients) used in China's agriculture industry. The company's liquid product is also efficient for farmers since it can be mixed with water and sprayed directly on the plants at the same time pesticides are applied. The company had earnings per share of $1.13 over the past 12 months, giving it a P/E ratio of just 4.69. It pays no dividend.

There you have it: You now know how to profit from inflation – but the key is to invest before the looming inflationary tsunami reaches.

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