On Wednesday, tame C.P.I. numbers sent investors cheering.
- Feb 25, 2005
- admin
- Investing
HIP-HIP HOORAAAY! HIP-HIP HOORAAY!
That was the sound coming from trading rooms around the world when
it was announced this week that the Consumer Price Index (CPI)
grew less than expected.
Why is this so important?
Because the CPI measures how much American 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 (SYM: HSY) 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 5 percent during the past 12 months.
5 percent’s a big number.
A 5 percent rise in producer prices means can have a devastating
effect on companies like Hershey (SYM: HSY).
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 5 percent more to make the chocolate then
your profit automatically declines by $4.
That means you have a net profit of $16 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 – in December
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.
Furthermore, you should look at your portfolio and decide what
stocks pose the biggest risks for you.
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Remember, you are what you read.
–Dylan Jovine