"Core" inflation numbers (excluding food and energy) appear to be tame.
But how many people do you know who don't eat or use gasoline?
-- By Dylan Jovine
HIP-HIP HOORAAAY! HIP-HIP HOORAAY!
That was the sound coming from trading rooms around the world when it was announced Core inflation numbers appear to be tame. Why is this so important? Because the inflation rate measures how much consumers can buy with each $1 they have in cash.
Let me give you an example. Let's say that last year you bought a Hershey Bar for $1. But now - in 2005 - the price of the same bar has risen to $1.05. That's an increase of 5 percent. Now that wouldn't be so bad if your salary increased by 5 percent as well. But wages generally increase at 2.5 percent per year.
So what does that mean to you? It means that you are actually LOSING 2 1/2 cents per year for every $1 you have. That's a net loss of 2.5 percent. That means that you lose $2,500.00 in purchasing power each year for every $100,000 you earn. That's a lot of chocolate.
But there's a bigger problem than chocolate. A problem that isn't here right now, but is RIGHT BENEATH THE SURFACE. The name of that problem is the Producer Price Index (PPI). That's the amount it costs COMPANIES to make the products they sell to YOU. And the PPI is rising.
As a matter of fact, the Producer Price Index (PPI) has risen a whopping .7 percent in October alone. .7 percent's a big number. A .7 percent rise in producer prices means can have a devastating effect on companies like Hershey. Let me tell you why:
If you sell $100 worth of chocolate each day and it cost you $80 to do it, you have a profit of $20 bucks. But if it costs you .7 percent more to make the chocolate then your profit automatically declines by almost $1. That means you have a net profit of $19 instead of $20.
That's not good.
What's even worse is that many companies cannot pass the price increase onto its customers. That means that the company eats the entire price increase itself. That causes profits to decline. And we all know what happens to stock prices when profits drop. Pretty rough.
But that's the bad news. Want to know the good news? Here it is: Some companies are able to raise prices above the inflation rate.
As a matter of fact, Hershey is one of them - last Decmber they announced that they were raising prices by almost 6 percent. That tells me two things:
1. Hershey is going to actually make $21 in profit for every $100 in chocolate it sells.
2. Hershey has a brand name that is powerful enough to make it happen.
But most companies don't have that luxury. Think about it. Some companies that you own in your portfolio don't have pricing power at all. They'll have to absorb the cost all by their lonesome. Thus, their profits are bound to decline along with their stocks. That means that you should keep a strong eye on producer prices.
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CEO, Founder & Director of Editorial Content
The Tycoon Report