At Berkshire Hathaway’s annual meeting this year, Warren Buffett claimed he was experiencing “quite big inflation”, and that homebuilding costs were “just going up, up, up.” In the past, the renowned investor has warned of the devastating effects of rising prices for stock pickers and businesses.
In a 1980 shareholder letter, Berkshire CEO Warren Buffett defined rising inflation as a “tax on capital” that discourages corporate investment. When prices rise, the “hurdle rate,” or the return on equity required to create a genuine return for investors, rises, he added. “The average tax-paying investor is now running up a down escalator whose pace has accelerated to the point where his upward progress is nil,” Buffett stated.
Inflation, the famed investor pointed out, might be more damaging than income taxes since it can turn a positive return on investment into a negative one. Buffett believes that if prices rise sufficiently, persons who earn a nominal return on their investment may find themselves with less purchasing power than before they invested.
Companies’ money is also eaten away by inflation, as rising expenses force them to spend the money they earn merely to maintain their current physical volume of business. That impact, according to Buffett, is an “especially ironic” punishment for failing enterprises. “Inflation takes us through the looking glass into the upside-down world of Alice in Wonderland,” he said. A bad business “must retain every nickel that it can,” he continued, even if it can’t deliver much of a return on those funds, and would prefer to distribute them to shareholders. The reason is that it needs the money and might well struggle to raise fresh funds.
Buffett also emphasized the painful impact of rising prices on all businesses. “Inflation acts as a gigantic corporate tapeworm,” he said. “That tapeworm preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism. Regardless of a company’s profits, it has to spend more on receivables, inventory, and fixed assets to simply equal the unit volume of the previous year,” he said.
The Berkshire chief also discussed the types of firms that can best withstand inflation. He claims that those with valuable intangible assets and minimal need for tangible things do well. IN his expert opinion, companies can also withstand higher pricing if they can do so without compromising significant market share or unit volumes, and respond to large dollar-volume increases in business without spending a lot of money.