How does inflation impact stock valuation?

Inflation has a significant impact on stock valuation primarily because it can erode purchasing power and influence the discount rates applied in valuation models. As inflation rises, the real value of future cash flows generated by a company tends to decrease. This is crucial because investors look at the present value of future earnings when determining a stock's value.

When inflation is high, it raises the nominal interest rates as well, which in turn affects the discount rates used in valuation models like Discounted Cash Flow (DCF). A higher discount rate reduces the present value of future cash flows, leading to a lower valuation of the stock. Additionally, if costs rise due to inflation—such as wages, raw materials, and other operating expenses—companies may see their profit margins squeezed, further impacting their valuations negatively.

Understanding these dynamics is essential for analysts evaluating investment opportunities within an inflationary environment, as it directly correlates to the profitability and financial health of companies. Hence, option C highlights the multi-faceted influence of inflation on stock valuation, making it the correct choice.