THE IMPORTANCE OF A FIRM’S LINE OF BUSINESS

The effect of inflation on a firm’s earnings and asset values depends in large part on the kind of business in which a firm is engaged. A business that produces goods or services for which it is relatively easy to raise prices may find that unexpected increases in inflation are fairly painless or perhaps, even desirable. The stockholders are thus likely to avoid much of the pain associated with inflation, although there is no reason to expect that dividends and the stock price will always move in proportion with inflation. Another important aspect of the extent to which a business will be able to compensate for unexpected inflation is the mix of the resources it employs to produce goods and services. Businesses that use large amounts of labor or significant quantities of price-sensitive materials are likely to discover that, proportionately, their costs increase more than the general rate of inflation. Even though these firms can raise the prices of their goods and services, they may find that cost increases outrun revenue increases, so that earnings are penalized. On the other hand, firms that use large amounts of fixed assets may find that their expenses increase only marginally, at least over the short or intermediate term.