Protecting Your Small Cap Portfolio From Inflation

by: Zacks Small-Cap

By Steve Anderson

The jury may still be out on whether or not inflation is knocking at the door, with both sides stressing compelling points of view.

Still, the creating of money, low rates and increasing budget deficit have caused the dollar to lose value and increase the threat of an inflationary period. In fact many top strategists, including Warren Buffett, have warned that they expect inflation in the future.

In March, the consumer price index showed a slight 0.5 percent increase while year over year CPI grew by only 2.7 percent.

However, the major components were a different story; energy grew by 3.5 percent, gasoline jumped 5.6 percent and food prices increased 0.8 percent.

While food price inflation lagged both energy and gasoline, don’t rule out the possibility of continued increases in this element. The increased demand in beef has already pushed cattle prices higher.

Furthermore, the U.S. Department of Agriculture recently raised its projections on the expected year over year price of ground beef and steak to increase 6 percent to 7 percent from its previous expectations of 4.5 percent to 5.5 percent year over year growth.

What’s more, the beef industry has been exporting more than it has imported since September 2010, which is a very uncommon occurrence. Also, there has been no indication of any expected decrease in summer corn consumption by cattle feeders.

Along the same lines, higher oil prices have caused increased ethanol consumption, which is helping push corn reserves toward their lowest levels since 1996.

Similarly, soybean stocks are the tightest in approximately 40 years.

As inflation expectations increase, there are a few things you can do to help protect your small cap portfolio for when inflation does in fact raise its ugly head.

Investors who believe the economy will flourish may wish to keep some of their small cap portfolio in growth stocks. However, when inflation and interest rates are rising, historically, value stocks have fared better then growth stocks.

Therefore some investors may wish to lower their exposure to the risk of rising inflation with a high dividend yield, low price/earnings strategy.

Additionally, investors can further protect their small cap portfolio from inflation by finding stocks with a few additional attributes.

The company’s product should remain in demand even with any increase in prices. Also, the company should be able to pass any price increase on to its customers and continue to have its end product in demand. In other words, you want the company to be able to sustain its current margins.

Finally, you don’t want the stock to be a flop if the Fed is able to keep inflation under control and or a bullish trend in the U.S. dollar begins to emerge.

Even though it may be hard to find small cap stocks fitting all this criteria, here are a few hitting the mark.

Although Artesian Resources Corporation (NASDAQ:ARTNA) may not have the most appealing valuation compared with some of the other companies mentioned, the water utilities company offers a 4.0% dividend yield and has raised distributions for 14 years in a row.

Artesian provides water, wastewater, and engineering services to its customers. The company currently trades at a price earnings of 18.9, which falls slightly below the company’s 5 year average P/E ratio and below the average P/E for the water utilities industry. The company has a Zacks Consensus recommendation of Buy.

Also, Avista Corporation (NYSE:AVA), may push the upper limits of fitting into a small cap portfolio with a market cap of $1.39 billion, the energy company easily fits into some of the other suggested categories.

The company transmits and distributes electricity and natural gas to residential, commercial and industrial customers in the United States and Canada as well as engages in wholesale purchases and sales of electricity and natural gas.

Despite Avista having had an attractive run since mid-March, the company still holds a price to book ratio of only 1.24 and a price/earnings of 14.8. Both of these valuation ratios fall slightly below the utilities electric power industry average.

What’s more, Avista yields an attractive 4.5% dividend yield which prices above its industry average. Similarly, in February 2011, Avista increased its quarterly dividend by 0.025 or 10% to $0.275/share, marking its ninth consecutive annual dividend increase. Avista has a Zacks rank of Hold while the average broker rating is Buy.

The environmental consulting firm, Ecology and Environment, Inc. (NASDAQ:EEI), may still be somewhat extended since reporting in mid-March of a six-fold increase in its second quarter earnings. Still, the global provider of professional services to the government and private sectors trades at a price earnings ratio of 13.1, which is well below both its 5 year average P/E and the average P/E of the pollution control industry. EEI pays an annual dividend of $0.44 per share which equals a respectable 2.3% yield.

The gas utilities company, Gas Natural Inc. (NYSEMKT:EGAS), is another utility fitting all the criteria. The Company distributes and sells natural gas to end-use residential, commercial and industrial customers in Maine, Montana, North Carolina, Ohio, Pennsylvania, and Wyoming. Gas Natural also holds interests in natural gas producing wells and gas gathering assets.

The Company currently pays an annual dividend of $0.54 per share, yielding an attractive 4.8%. The dividend yield is over 50% higher than the average dividend yield for the gas utilities industry and more than doubles the average dividend yield of the S&P 500 (NYSEARCA:SPY).

Gas Natural currently trades at a low price earnings ratio of 11.6 and price to book of 1.2. The Zacks rank on Gas Natural is Buy while the average broker rating is a Strong Buy.

Lincoln Educational Services Corporation (NASDAQ:LINC), a for-profit, provider of post-secondary education services company, may not fit the “remaining in demand with increased price” attribute as nicely as some of the utility companies mentioned.

Still, the Company trades at a price earnings of more than 50% below the average price earnings for the education and training services industry. Furthermore, Lincoln Educational Services pays out an annual dividend of $1.00 per share, which equates to an attractive 6% dividend yield. The Zacks Consensus rating on Lincoln is a Buy.

The property and casualty insurance company, Maiden Holdings, Ltd. (NASDAQ:MHLD), provides non-catastrophe property and inland marine reinsurance solutions to regional and specialty insurers in the United States and Europe.

Maiden trades at a discount to its book value and has an appealing PEG ratio of 0.63. Furthermore, the dividend yield of 3.8% is more than double the average dividend yield for the property and casualty insurance industry. The company’s average broker recommendation is Strong Buy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.