How Buffett investment during inflation - Orient Securities Research Institute

 Buffett: Inflation during the how to invest - Orient Securities Research Institute 

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Buffett: Inflation during the how to invest - Orient Securities Research Institute

2009-06-22 Dynamic analysis of stock market

This article was first published in May 1977 in the Contemporary investors will benefit.

Buffett believes that in terms of economic nature, in fact very similar to stocks and bonds, stock shares, but is wearing a coat to the fancy dress party on Wall Street Because the nature of the stock and bonds are very similar to the stock by the effect of inflation is also very large. Inflation transfer wealth to improve the income of the shareholders the potential for welfare of workers is not large. To generate more economic benefits, we need a substantial increase in real capital, and investment in modern production facilities. In addition, the effects of inflation real capital accumulation, expansion of some enterprises after the payment of funds depleted, the companies issuing new shares in the dividend and the games between the end of injury or investors. Inflation rate of return of the enterprise are universal, but requires a lot of expenditure on tangible assets to maintain the business enterprises tend to hurt more by inflation; needs of enterprise expenditure on tangible assets less harm to a lesser extent; economy companies with high goodwill also less subject to damage ... ...

similar to stocks and bonds in the inflation environment, poor performance, it is no secret. Over the past ten years (the sixties and seventies), most of the time we are in an inflationary environment in the stock, this is a difficult period.

However, people in the stock market during this period because of the understanding is still insufficient. Problems of inflation during the bondholders is not difficult to understand. When the dollar value of the monthly deterioration of income and principal in U.S. dollars of securities will not be a big winner.

stocks and bonds has long been that different. For many years, it is generally accepted that stocks can hedge against inflation risk. Produce the source of this understanding is that the stock is not representative claims, but has the ownership of the company production facilities. Investors that, no matter how the Government printing money, the company's production facilities will be able to maintain their real value.

But why backfire? I think mainly due to the economic nature, in fact very similar to stocks and bonds.

I know that for many investors, this argument may sound strange, they will quickly retort that the return on bonds is fixed, annual rate of return on equity investment fluctuations. However, if you carefully examine the company's total return after World War II, you will find a surprising phenomenon: the return on equity, in fact little change.

coupon stock is fixed

the first decade after World War II (1946-1955), the Dow Jones industrial average annual return of 12.8%. The next decade, the figure was 10.1%. The following decade, the return was 10.9%. However, for many years in general, tend to book value of the rate of return of 12%. Years of inflation, there is no indication that the rate of return significantly more than this level, in the years when price stability is the same. Now, we as a manufacturer of these companies, rather than listed stocks. Assuming the business owner to buy shares at the net. Well, they will also be the return of their own about 12%. Because of this high consistency rate of return, we can reasonably assume it to

, of course, in the real world, not just stock investors buy and hold long term. Instead, investors to invest in the share of the company's profit distribution in a larger cup of soup, Yong war between wits. Obviously, the whole, this chaos in vain, to no impact on equity coupon is only reduced investors should obtain, because frequent trading produces a lot of friction costs, such as advisory fees, brokerage commissions. The existence of an active options market to further increase the cost of friction, the casino-like market did not improve the productivity of U.S. companies, but it requires thousands of people in this labor.

stock is permanent

Another fact is that stock investors in the real world is not usually buy the stock at book value. Sometimes they can buy less than book value, but most of the time higher than the book value purchase price, this happens, the 12% rate of return is even greater pressure. With inflation and no increase in return on equity capital. In essence, buy the shares get is inherently fixed rate securities, which are the same and buy bonds.

, of course, in the form of bonds and stocks have a significant difference. First, the bonds will eventually expire, perhaps the long-term investors need to wait, but eventually investors will be able to re-negotiated contract terms. If the current or expected inflation rate coupon makes less than his past, he may refuse to further the game, unless the supply of coupons can now rekindle his interest. Similar situations have occurred in recent years.

However, the stock is permanent. Maturity of the stock infinity. Stock investors locked in gains earned by U.S. firms can, no matter how many. If corporate America is bound to be the rate of return of 12%, then investors must accept the return. Overall, neither equity investors to exit, can not re-negotiate the contract terms. Individual companies may be sold or liquidated, the company may repurchase shares. However, overall, new issues and retained earnings to ensure that our system will increase the equity capital.

So, we hit a point to the form of bonds. Coupon bonds will eventually be re-negotiated equity Of course, we must admit that the long-term rate of return of 12% coupon does not appear to require significant changes.

wearing

our stock, but is wearing a coat to the Wall Street stock fancy dress party of the

ordinary bonds and the return rate was 12% of the Normally, bond investors receive all cash coupon, you can freely re-investment. In contrast, stock investors some of the equity coupon retained by the company, its re-investment rate of return can only be the company's rate of return. In other words, 12% annual rate of return of part of the dividend, the remainder being invested in the company, and then generate 12% return rate.

high inflation, high interest rate era - the stock lost its investors have quit

look back ,1946-1966 years, investors may think they got really points the three cups full of soup. First, they benefit from the interest rate was much higher than the rate of return on equity. Second, the company will be a large return on equity and access to higher reinvestment rate of return is difficult to obtain by other means such a high rate of return. Third, as is widely recognized that the first two advantages, stock investors also benefit from the appreciation of equity capital. This means that, in addition to about 12% of basic share capital return on capital, the investors also received a bonus, this part of the dividends from the Dow's book value from 1.33 times in 1946, rose to 2.20 in 1966 times the benefits. Increase in the valuation process, investors temporarily invested enterprises earned more than the inherent profitability of its rate of return.

to 60 mid and large institutional investors finally found the investment in However, in these financial giants began to compete to buy shares, we entered the accelerated inflation, the era of higher interest rates. Reverse the rising valuation process begins, which is quite logical. Inexorably rising interest rates reduce the investment of all existing fixed coupon value of the subject. With the long-term corporate bond rates start to rise (and eventually rose to 10%), and shares 12% of the equity rate of return and re-investment privileges are pale.

assumed that stocks were risky than bonds, which is understandable. Although the share capital of the largely fixed coupon in the long run, but every year there is indeed a fluctuation. The attitude of investors in the future, subject to considerable annual fluctuations, although this effect is often wrong. Another big equity risk factor is the maturity of their infinitely long. As this layer of additional risk, investors expect the natural reaction is secure in return on equity than bond returns, for example, if the return on bonds is 10%, then the same type of shares issued by the company's return on equity of 12% can not be regarded as With the spread down, began to seek out stock investors.

However, stock investors as a whole can not quit. They can do is a lot of hands, a large amount of friction costs, followed by valuation levels dropped significantly, because 12% of the share capital of the coupon in less attractive in an inflationary environment. Over the past 10 years, bond investors through a series of shocks, in the process, they found that the level of any coupons - either 6%, 8% or 10% - are not doomed, bond prices also will collapse. Most stock investors do not realize they also have a

enterprises to improve the profitability of the five methods is difficult in an inflationary environment of ridiculous

we must consider that 12% of the equity coupon is immutable? Is there any law that the company's return on equity capital continues to rise in the inflation environment, it can not be adjusted upward?

of course, no such law. However, on the other hand, the United States can not be arbitrary or through legislation to improve the company profitability. To improve the return on equity, companies need to do at least the following point: (1) increase turnover, that is, sales and business use of total assets; (2) leverage the use of more expensive; (3) use more leverage; (4) reduce the income tax; (5) increased operating margins.

addition to these, I am afraid to increase return on ordinary shares of no other way. Whether these methods can not improve during the inflation, the company's equity capital rate of return? Below we will carefully described.

first, to increase turnover. About this, we need to consider three major asset categories: accounts receivable, inventory, fixed assets.

accounts receivable growth and increases in proportion to sales, whether sales growth by volume growth, price increases or by the driver. This is no increase in space.

The inventory situation is not so simple. The long term, following the trend of flat stock unit sales trend. However, the short term, the inventory turnover rate may be due to factors such as the expected cost or the impact of the bottleneck up and down.

use the When sales rise due to inflation, using the But in any case, the amount of turnover rate.

20 century and the early 70s, the company using the This trend seems to slow. However, many use the

turnover rate of inflation rose marginally

to fixed assets, as long as the rise in the inflation rate, the first result is to enhance turnover. This is because sales will immediately reflect the new price level, but on account of fixed assets reflect changes only slowly, that is, with the retirement of existing assets and the new price is reset to reflect the changes. Obviously, the slower the company's relocation process, turnover rose more. However, when the company's replacement cycle is complete, the turnover rate will not be so up. Assuming the inflation rate stability, sales and fixed assets will begin to rise with inflation rate constant.

Overall, the turnover rate of inflation can bring a certain degree of increase. Part of the increase is certain, since the use of However, the turnover rate of inflation rise is limited, the rate of return on equity capital sufficient to lead to a significant increase.

then use the leverage it can bring cheaper rate of return on equity capital increase? unlikely. High inflation often leads to increased borrowing costs, rather than decrease. Capital requirements led to soaring inflation rate soared, as lenders worry about long-term loan contracts deepening, more and more stringent loan conditions. However, even if interest rates will not rise further, leverage will become more expensive because the company carrying on the average cost of debt is less than replacement cost. After the expiration of existing debt, need to be replaced. Overall, the cost of future changes in leverage on return on equity may have a slight inhibition.

lenders willing to lend?

financing needs caused by inflation, ironically, is that companies need high profit margins relatively low debt to capital; but low profit margins on the debt of companies seem to Yuhenantian. Lender awareness of the issue now know more than before, so not quite willing to lend to those capital demand, low profit margins so that they substantially increase the company leverage.

However, in an inflationary environment, many companies seem to be the future by increasing leverage to increase return on equity. Management do so because they need a lot of capital, they want to cut dividend or issue new shares do not need to be able to obtain large amounts of capital, because in an inflationary environment attractive to new shares issued is not significant. Therefore, regardless of the cost of their natural reaction is to a large scale borrowing.

However, the current loan interest rates increase the return on equity to enhance the role and the early 60's 4% interest rate for loans far cry from the role. To make matters worse, the debt ratio will also lead to increased credit rating downgrades, leading to further rise in interest costs.

Therefore, in addition to previously outlined, the above reasons will lead to leverage costs. Overall, the downside of leverage costs may offset the benefits of increased leverage.

addition, the U.S. company's debt is much higher than the traditional system, the balance sheet shows the level. Many companies have a huge pension obligations, the number and the company's current employees upon retirement linked to wage levels. In 1955-1965 years, low interest rate environment, the debt from these pension plans is reasonably predictable. Today, no one can say clearly how much the company ultimately obligations.

, of course, on both an annual report on the performance of the pension debt is not accurate data. If the authenticity and reliability of this data, then the number of companies can pre-pay this amount, add it to the existing pension assets, pension assets will be left to an insurance company, all of it to bear the company's pension liabilities are . Alas, I am afraid that in the real world could not find one willing to listen to the transaction of insurance companies.

United States, almost every issue of the company's accounting thought However, by the burden of private sector pension system, the U.S. has the burdens of the companies in fact equivalent to a surprising number of the bond debt.

shareholders should be viewed with a critical eye the increase in leverage, whether it is traditional debt, or not accounted for with the price-linked In the case of non-liability company obtained a 12% rate of return is much better than the debt-ridden enterprises to obtain the same rate of return. This means that now the company's return on equity of 12% of the value is far less than 20 years ago, the rate of return of 12% of the value. reduce the income tax is not feasible



reduce the corporate income tax seems unlikely to improve the return on equity capital. Held by U.S. investors in the company's stock can only be counted as class D, A, B, C class were federal, state and municipal governments hold,UGG bailey button, the representative of the rights of their income tax. Although these

the A, B, C stocks, another attractive feature is that as long as any kind of payment is required, for example, holders of the shares of Class A (Federal Government), as long as Congress can take action. Even more interesting is that sometimes one type of security holders will vote back possession of the enterprise to improve their share of the company in New York in 1975,Discount UGG boots, very frustrating to find out the situation. Whenever A, B, C class

Looking ahead, the long term, that A, B, C class of stock control would reduce their share of the vote would be unwise. Class D shareholders will likely have to work hard to maintain their own share.

FTC statistics show that operating margins decline in inflation

we mentioned above, the five ways to increase return on equity, the last one is to improve operating margins. Some optimists hope that this approach can significantly improve the return on equity. There is no evidence they were wrong. However, the $ 1 in sales in only 100 cents, we get the residual value, pre-tax profits, and this $ 1 of net sales but also a number of expenditure, major projects, including labor, raw materials, energy, and a variety of inter taxes other than income taxes. Inflation period, the relative importance of these costs seems difficult to decline.

Moreover, the recent statistical evidence does not support the view that inflation margin expanded during the argument. In 1956-1965 this period of relatively low inflation, the Federal Trade Commission (FTC) report on the manufacturing companies each quarter pre-tax average annual return on sales was 8.6%. 1966-1975 years, the average profit margin is 8%. In other words, despite the significant increase in the inflation rate, the company profit margins declined.

replacement cost if the enterprise in accordance with the pricing, profit margins will expand in the inflation period. However, a simple fact is that, although most large enterprises have widespread influence on the market confidence, but they failed to do the replacement cost pricing. Replacement cost method of accounting is almost always shown over the past decade, a substantial decline in corporate profits. If you like oil, steel and aluminum and other major industries veritable monopoly power, then we can only think highly of their pricing policy constraints.

above may increase the return on common stock of the five factors are finished. In my opinion, the inflation period, the effectiveness of these methods are not large. Maybe you're more optimistic after completing the analysis, but remember that 12% rate of return has been with us for many years.

future earnings three factors: book value and market value of the relationship between tax rates and inflation rate

Maybe you agree with the 12% rate of return on equity of more or less fixed, however you want in the coming years are still making good returns. This is understandable, after all, a long time, many investors earnings are good. However, your future earnings will depend on three variables: book value and market value of the relationship between tax rates and inflation rates.

us to simply calculate the book value and market value. When the stock price has been equal to book value, everything is very simple. If the stock's book value is 100 dollars, the average market value is $ 100, corporate earnings will be 12% of investors 12% returns. If the dividend payout ratio is 50%, the investor will receive a $ 6 dividend, and the increase in book value from the enterprise to obtain another $ 6, $ 6 which will naturally be reflected in the investors in the market value of shares held.

If the stock price is 150% of book value, the whole situation changed. Investors also will receive $ 6 cash dividend, but the return rate of only 4% of the cost. Book value of the enterprise will also rose by 6% to $ 106, the market value of the shares held by investors in a similar manner also rose 6% to $ 159. However, the total return investors - including stock appreciation and dividends - only 10%, 12% lower than the corporate rate of return of the original.

for less than book value when investors buy shares when the price, just reversed the process. For example, if the stock price is 80% of book value, assuming that earnings and dividend payout ratio, and the cases of the same, then the dividend yield would be 7.6% (6 / 80), the stock appreciated by 6%,cheap UGG boots, the total return of 13.5%. In other words, a discount to buy shares is higher than the rate of return premium to buy shares, it is common sense.

100%. Assuming the future of this ratio is close to 100%, which means that stock investors will get 12% of all corporate returns, at least they contain inflation, the tax rate of return of 12%.

inflation is a tax, income after deduction of the number?

inflation is to develop a legislative body than any of our taxes are more damaging taxes. Inflation tax has engulfed the capital of the wonderful features.

If I close the inflation rate assumption is correct, then even if the market rises, the result is still disappointing. Last month, the Dow is about 920 points, compared to 10 years rose 55 points. However, when adjusted for inflation, the Dow fell about 345 points - fell to 520 points from 865 points. Even to get this result, the Dow component companies have about half of the income is not distributed to owners, but the re-investment.

the next decade, only 12% of the equity interest count votes, 40% dividend payout ratio and the current 110% of book value, the Dow will double. Taking into account the inflation rate of 7% in the 1800 sale of stock investors to pay capital gains tax on the actual situation of the poor more than it is now.

Here, I can almost hear the pessimistic investors to predict the response I had. They may think that, regardless of the investment environment in the future, what kind of difficulties faced, they always strive to turn in an excellent investment in their own responses. Their success may not be large, of course, investors whole, can not succeed. If you think you can sell a whim to buy the securities, and gains more than the inflation rate, I'd like to be your agent, but not partners. Even the so-called tax-free

investors - pension funds, university endowment funds - can not escape the inflation tax. If I assume that the 7% inflation rate is correct, then the University of accounting should be the top 7% of annual revenue on purchasing power just as a supplement. Endowment Fund rate of return if less than 7%, they actually earn nothing. If the inflation rate of 7%, 8% of the overall investment rate of return, then, these institutions from the fact that the tax-free to pay 87.5% of the

inflation real capital accumulation, after the payment of funds running low expansion

To understand the effect of inflation on real capital accumulation, requires a little calculation. We do return to the 12% return on equity capital, net of depreciation of the profits should be allowed to reset the existing capacity.

we assume that half of the profits distributed as dividends out of the remaining 6% of equity capital for future growth. If inflation is low, a large part of the company's growth is real growth in physical output. Because in this case, in order to replicate this year's physical output, the second year into the accounts receivable, inventory and fixed assets, funds must be increased by 2%, so only 4% of the incremental investment in physical output section. That is, the amount of 2% growth in funding for the Unreal, reflect inflation; the remaining 4% real growth in funding. If the population growth of 1%, the actual increase in output to bring the per capita net income grew 4% 3%. We used the per capita net income growth of economy is basically in this level.

Now we do another operation. If the inflation rate is 7%, dividend policies and leverage ratios remain the same, consider the inflation component, the remaining zero real growth. 12% of the profits in the half for the dividend, the remaining 6% of all used to maintain the volume of business last year, the increase in funding. Many companies do not actually post in the normal dividend retained earnings to finance for business expansion, they began to ask how we can reduce the dividend at the same time not annoy shareholders? I give them a good news, we already have such programs the.

recent years, the dividend capacity of the power generation industry little or none. In other words, if investors agree to buy their shares, they have the ability to dividend. In 1975, the power industry to pay common stock dividend of 3.3 billion, require investors to return 3.4 billion. Of course, they cleverly decided to shattering, so to avoid repeating the mistakes of Con Ed's. In 1974, Con Ed is simply to tell investors the company unable to pay dividends. The company frank but unwise in the capital markets in return was a disaster.

smart little utilities companies to maintain and even increase its quarterly dividend levels, and then ask the new and old shareholders send your money back. In other words, the company issued new shares. This approach would give huge tax department of capital and underwriters. However, it seems everyone is high spirits, especially the underwriters. Perhaps the Government is the solution

end it

actual as companies grapple with the problem of capital accumulation is expected to cut dividends this approach will be more widely used. However, the controlling shareholder can not completely solve the problem. Inflation rate of 7% and 12% rate of return led to real growth to meet the company's future cash flow less required.

Thus, with the traditional method of private capital accumulation has become precarious in the face of inflation, our government will increasingly attempt to influence the industry's capital inflows, they may fail as the United Kingdom, or, as the Japanese as a success. United States does not have Japanese-style, government, business and labor required close cooperation of cultural and historical background of the soil. If you're lucky, we might be able to avoid the steps the UK has followed in the UK, the distribution of various groups around the cake, the cake bigger rather than battling third.

short, over time, we may hear more about the investment, stagflation and the private sector can not meet the needs of the story.

with: inflation environment is expected to better company performance Since

impact of inflation on corporate profits is universal, then what hurt small companies? in 1983 letter to shareholders,Bailey UGG boots, Buffett pointed out that although a long time people think that natural resources, plant, machinery or other tangible assets of most companies provide a wealth of inflation protection, but not the case. Net tangible assets of any need for operating expenditures are non-leveraged companies will be hurt by inflation. Requires very little expenditure on tangible assets, the smallest businesses hurt by inflation. Return on assets of businesses typically low weight, and its rate of return is often insufficient to meet the inflation of the company's existing business operations, capital requirements, there is no remaining funds to support real growth in dividends to shareholders, to acquire new business. In contrast, inflation in the years in the wealth accumulated, those smaller demand for tangible assets, intangible assets with lasting value, accounting for a larger enterprise. Period of inflation, economic goodwill (not accounting goodwill) can continue to create value, because the real economic value of goodwill in the name is usually proportional to growth and inflation.

in 1981 letter to shareholders, Buffett noted that Berkshire Hathaway's acquisition of the two types of company results are very beautiful, one of which happens to be well adapted to the inflation environment of the enterprise. Such companies must have two characteristics: (1) have the ability without worrying about market share and unit of production dropped significantly in the case of easily raise prices (even when the steady demand, production capacity has not been fully utilized as it can), ( 2) have the ability to significantly increase the amount of corporate output (more is due to inflation than real growth) and less need to coordinate the additional capital investment.