Learn to invest with Buffett

Chapter 22

Chapter 3, Section 6 Keep an Eye on Inflation
Inflation is a disaster, but behind this disaster will also bring good news to investors.

--Warren Buffett
Inflation is an important macroeconomic factor that affects the stock market and stock prices.The impact of this factor on the stock market is more complicated.It not only stimulates the stock market, but also depresses the stock market.Inflation is mainly caused by increasing the money supply too much.

Buffett always believes that inflation is a political phenomenon rather than an economic phenomenon.Because so far, there are still no strict restrictions on government spending.The continuous printing of money drives inflation higher and higher.Deficit spending inevitably leads to inflation.Buffett fears budget deficits less than trade deficits.Because of the strength of the U.S. economy, Buffett believes the country can handle budget deficits.But Buffett is very concerned about the trade deficit.It can be said that the trade deficit is an indispensable factor in forming his "prejudice" against inflation.

Buffett is well aware that the easiest way for a country to deal with its trade deficit is to reduce the value of these bills of lading through high domestic inflation.But Buffett believes that when the bills of lading held by foreigners reach an unmanageable level, the temptation of inflation will be irresistible.For a debtor country, inflation is a hydrogen bomb-level economic tool.For this reason, very few debtor countries are allowed to pay their debts in their own currency, but because of the integrity of the American economy, foreigners are willing to buy our debt.But if we use inflation to escape our debts to foreign countries, it will not only be the foreign creditors who will suffer as a result.

Generally speaking, inflation has a great impact on investors.The level of inflation is equal to the loss of real value of cash in hand.Assuming that the inflation rate is 25%, the real purchasing power will decrease by 25%.Buffett believes that at least a 25% return on investment is required to maintain real purchasing power.

Therefore, inflation is the enemy to most investors.But there are also some people who can benefit from inflation.Those who buy a home with a 30-year 5% mortgage benefit from inflation because their income will increase, and the mortgage interest they must pay is fixed.Companies also benefit from inflation. Those who successfully persuaded investors to provide funds to companies at fixed rates for long-term use in the 20s can also repay loan interest at a lower cost because of inflation, so Investors are the biggest victims of inflation, because the real purchasing power is relatively smaller.

In the 20s, if an investor bought GM's corporate bonds for $60, the $4000 at that time could be used to buy a new car. The sum of money can only buy 4000/90 of a new car.All investors must consider the impact of inflation.

Berkshire paid about $1972 million to buy See's in 3500, which was equivalent to an 8% after-tax return. Compared with the 5.8% return provided by the government bonds that year, See's after-tax return A rate of 8% is obviously not bad.Buffett also benefits from inflation.

Buffett pointed out that high inflation has increased the burden on companies on shareholder returns.In order for investors to achieve real gains, the company must achieve a return on capital that is higher than the investor's pain index.The misery index refers to the sum of tax payments (dividend income tax and capital gains tax) plus inflation.

Buffett believes that income taxes never turn a company's positive returns into negative returns for shareholders.If the inflation rate is 0, even if the tax rate is 90%, there will still be shareholder gains.But, as Buffett witnessed in the late 70s, as inflation rises, companies must provide shareholders with a higher return on equity capital.For a company with a 20% return on assets (a feat Buffett believes is rarely achieved), 12% inflation leaves very little for shareholders.When the tax rate is 50%, a company with a return on assets of 20% and all its income paid out in dividends has an effective net rate of return of only 10%.With an inflation rate of 12%, shareholders can only obtain 98% of the purchasing power at the beginning of the year.When the tax rate is 32%, if the inflation rate is 8%, the return on equity of a company with a return on equity of 12% drops to zero for shareholders.

Conventional wisdom has held for years that stocks are a hedge against inflation.Investors also tend to believe that companies will naturally pass the cost of inflation on to consumers, thereby protecting the value of their investments for company shareholders.Buffett believes that inflation does not guarantee a company a higher rate of return on equity capital.There are generally five ways a company can increase its return on equity capital:

1. Increase asset turnover (the ratio of sales to total assets);
2. Increase operating profit;

3. Reduce taxes;

4. Increase the financial leverage ratio (that is, increase the debt ratio);
5. Use cheaper financial leverage (i.e. debt with lower interest rates).

Buffett believes that inflation is in fact ubiquitous, and it can create the illusion of increased wealth. If you paid $30 for a house 10 years ago that is now worth $50, you won't be secretly happy.Even if you decide to sell your old house and buy a new one of the same size for $50, you still feel richer. Thirty years ago, your annual income was $30, and your annual income is now $2, although you think you are making more money, in fact, the real purchasing power of this $10 is not much higher than the real purchasing power of $10 30 years ago.So, have you gotten rich?actually not.If your income is fixed, if you buy long-term bonds or hold cash on hand, your real wealth will mostly decrease.

Buffett admits he cannot predict when hyperinflation will recur.But continued deterioration in deficit spending will make inflation inevitable.

Buffett is good at choosing companies that can generate higher profits with smaller net tangible assets. Because of this advantage, even if they are affected by inflation, the market still allows these companies to have higher price-to-earnings ratios.Although inflation will hurt many companies, those companies with consumption exclusivity will not be harmed, on the contrary, they can benefit from it.

Inflation not only stimulates the stock market, but also depresses the stock market. It is an important macroeconomic factor that affects the stock market and stock prices.Inflation is mainly caused by increasing the money supply too much.The money supply and stock prices are generally proportional, that is, the increase of the money supply makes the stock price rise, and conversely, the shrinking of the money supply makes the stock price fall, but in special cases, it has the opposite effect.

The impact of money supply on stock prices has three manifestations:

First, the increase in the money supply can, on the one hand, promote production, support the price level, and prevent the decline in commodity profits; on the other hand, it will increase the demand for stocks and promote the prosperity of the stock market.

Second, the increase in money supply causes the price of social commodities to rise, and the sales revenue and profits of joint-stock companies increase accordingly, so that the dividends expressed in currency (that is, the nominal return of stocks) will rise to a certain extent, and the demand for stocks will increase. , and the stock price rises accordingly.

Third, the continuous increase in the money supply leads to inflation. Inflation often brings false market prosperity, creating a false impression that corporate profits are generally rising. The awareness of value preservation makes people tend to invest money in precious metals, real estate and short-term assets. As with bonds, the demand for stocks will also increase, causing a corresponding increase in stock prices.

It can be seen that the increase and decrease of money supply is one of the important reasons affecting the rise and fall of stock prices.When the money supply increases, the excess social purchasing power will be invested in the stock market, thereby driving up the stock price; on the contrary, if the money supply decreases and the social purchasing power decreases, investment will decrease, and the stock market will fall into a downturn, so the stock price will inevitably rise. will be affected.On the other hand, when inflation reaches a certain level, and the inflation rate even exceeds double digits, interest rates will rise, capital will flow out of the stock market, and stock prices will fall.

In short, when inflation has a strong stimulating effect on the stock market, the trend of the stock market is consistent with that of inflation; and when its depressive effect is large, the trend of the stock market is opposite to that of inflation.

Investment motto:

Even if you can't profit from inflation, you can find other ways to avoid companies that would be hurt by inflation.Generally speaking, businesses that require large amounts of fixed assets to stay in business tend to be hurt by inflation; businesses that require fewer fixed assets are also hurt by inflation, but to a much lesser extent; economic goodwill Higher firms are hurt the least.

(End of this chapter)