What is the Impact of Inflation on Valuation?

What is Inflation?

In economics - Inflation is defined as the rate of increase in prices over a given period. To illustrate the concept of inflation, we can think about a theoretical bundle of products sold a month ago for 100 USD. The bundle costs 105 USD this month. The result is that the prices increased by 5% during the month, and the inflation rate equals 5%.

How does Inflation Affect Valuation?

Intuitively - during periods of inflation, the company raises its prices. Therefore, its income increases as well as its value. However, in reality - the question of the impact of Inflation on valuation is ambitious.
It depends if the company is edged against inflation or not.

Most chances are that the company will not increase the prices of the services and products for no reason. A price increase will stem from the company's production factor elevator - wage prices, rent prices, and more.

If the company is not edged against inflation, it cannot increase the prices of products and services when inflation rises. In that case, the firm's profit margin will diminish and, as a result, the firm's value.

If the company is edged against inflation, it means that the company will be able to increase its prices during periods of inflation. In that case, the value can increase or decrease - depending on the question - at what rate can the firm raise the prices? Is it more than an increase in the prices of factors of production or less?

If the firm's suppliers raise prices by 10% and the firm manages to raise prices by only 5% - its value can go down, but if it works to increase prices by 15% - its value can go up.

Why have we used the terms "can go up" and "can go down" and not the terms "go up" and "go down"?
The answer is related to the economic term - Price Elasticity of Demand. In economics, Price Elasticity of Demand describes the change in demand for products due to a change in product prices. It is likely that when a company raises prices - the demand for its products is expected to fall, and when it lowers prices - the demand for products is expected to rise. But the question is how much?

In summary - it can be described:
If the firm is not hedged against rising input prices - it will not be able to raise prices - and its value will decrease.
If the firm is hedged against price increases, it can raise its prices - and then the question arises whether its redemption will increase or decrease?
In case the firm's redemption increases beyond the additional cost caused to the firm, as a result of the rise in the prices of the factors of production, the firm's value is expected to increase.

the following infographic describes the impact of inflation on valuation (it can be used for free - with mention of the current url)

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