This is what you should invest in, and why, as inflation rears its head

What’s one to do?

With bank interest rates stuck near zero, savers and investors are seeking higher yields. The need for a better return on our household savings becomes more pressing when we see inflation rearing its ugly head.

However, many investors are concerned that the stock market is too risky, given that prices are now at all-time highs. Facing such concerns, some consider buying so-called alternative investments, like commodity funds or leveraged-loan portfolios.

But is the stock market really too risky? If inflation is the problem, stocks are actually your best protection. Economic theory and historical evidence show that the best hedge against inflation over time is an investment in business. Stocks have outperformed other assets, like commodities and real estate, over reasonable investor time horizons.

Even with the run-up since last year, stocks are priced well compared to the alternatives.

The most common estimate of a stock’s expected return, popularized long ago by legendary investor Benjamin Graham, is found by comparing the net income of the company to the price of its stock. This rate of return is the inverse of a stock’s price-to-earnings, or PE, ratio.

The earnings yield on the S&P 500 stock index is currently just under 3%, more than double the current yield-to-maturity on 10-year U.S. government bonds. The earnings yield on the stocks of some prominent Idaho companies shows even better value.

Albertsons Companies Inc. has a current PE ratio of 25, or an earnings yield of 4%. Eagle-based Lamb Weston Holdings has a PE ratio of over 30, which still implies a more than 3% earnings yield.

Furthermore, these two local companies pay quarterly dividends to investors. The current dividend yields (dividend payment divided by price) for both companies also exceed government bond rates. So even with the elevated stock prices these local companies and the overall stock market are expected to produce long-run returns well above, and current returns just above, those on a savings account or government bond.

One need not go looking for a higher yield on one’s savings in some dark corner of the financial markets. For inflation protection and long-run return, just stick with stocks.

Peter Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa, Idaho. prcrabb@nnu.edu