How Inflation Swindles the Equity Investor.docx

1、How Inflation Swindles the Equity InvestorHow Inflation Swindles the Equity Investor - by Warren Buffett2011-05-18 16:25:44The central problem in the stock market is that the return on capital hasnt risen with inflation. It seems to be stuck at 12 percent.by Warren E. Buffett, FORTUNE May 1977It is

2、no longer a secret that stocks, like bonds, do poorly in an inflationary environment. We have been in such an environment for most of the past decade, and it has indeed been a time of troubles for stocks. But the reasons for the stock markets problems in this period are still imperfectly understood.

3、There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isnt going to be a big winner. You hardly need a Ph.D. in economics to figure t

4、hat one out.It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with pro

5、ductive facilities. These, investors believed, would retain their Value in real terms, let the politicians print money as they might.And why didnt it turn but that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds.I know that this belief will se

6、em eccentric to many investors. Thay will immediately observe that the return on a bond (the coupon) is fixed, while the return on an equity investment (the companys earnings) can vary substantially from one year to another. True enough. But anyone who examines the aggregate returns that have been e

7、arned by compa-nies during the postwar years will dis-cover something extraordinary: the returns on equity have in fact not varied much at all.The coupon is stickyIn the first ten years after the war - the decade ending in 1955 -the Dow Jones industrials had an average annual return on year-end equi

8、ty of 12.8 percent. In the second decade, the figure was 10.1 percent. In the third decade it was 10.9 percent. Data for a larger universe, the FORTUNE 500 (whose history goes back only to the mid-1950s), indicate somewhat similar results: 11.2 percent in the decade ending in 1965, 11.8 percent in t

9、he decade through 1975. The figures for a few exceptional years have been substantially higher (the high for the 500 was 14.1 percent in 1974) or lower (9.5 percent in 1958 and 1970), but over the years, and in the aggregate, the return on book value tends to keep coming back to a level around 12 pe

10、rcent. It shows no signs of exceeding that level significantly in inflationary years (or in years of stable prices, for that matter).For the moment, lets think of those companies, not as listed stocks, but as productive enterprises. Lets also assume that the owners of those enterprises had acquired

11、them at book value. In that case, their own return would have been around 12 percent too. And because the return has been so consistent, it seems reasonable to think of it as an equity coupon.In the real world, of course, investors in stocks dont just buy and hold. Instead, many try to outwit their

12、fellow investors in order to maximize their own proportions of corporate earnings. This thrashing about, obviously fruitless in aggregate, has no impact on the equity, coupon but reduces the investors portion of it, because he incurs substantial frictional costs, such as advisory fees and brokerage

13、charges. Throw in an active options market, which adds nothing to, the productivity of American enterprise but requires a cast of thousands to man the casino, and frictional costs rise further.Stocks are perpetualIt is also true that in the real world investors in stocks dont usually get to buy at b

14、ook value. Sometimes they have been able to buy in below book; usually, however, theyve had to pay more than book, and when that happens there is further pressure on that 12 percent. Ill talk more about these relationships later. Meanwhile, lets focus on the main point: as inflation has increased, t

15、he return on equity capital has not. Essentially, those who buy equities receive securities with an underlying fixed return - just like those who buy bonds.Of course, there are some important differences between the bond and stock forms. For openers, bonds eventually come due. It may require a long

16、wait, but eventually the bond investor gets to renegotiate the terms of his contract. If current and prospective rates of inflation make his old coupon look inadequate, he can refuse to play further unless coupons currently being offered rekindle his interest. Something of this sort has been going o

17、n in recent years.Stocks, on the other hand, are perpetual. They have a maturity date of infinity. Investors in stocks are stuck with whatever return corporate America happens to earn. If corporate America is destined to earn 12 percent, then that is the level investors must learn to live with. As a

18、 group, stock investors can neither opt out nor renegotiate. In the aggregate, their commitment is actually increasing. Individual companies can be sold or liquidated and corporations can repurchase their own shares; on balance, however, new equity flotations and retained earnings guarantee that the

19、 equity capital locked up in the corporate system will increase.So, score one for the bond form. Bond coupons eventually will be renegotiated; equity coupons wont. It is true, of course, that for a long time a 12 percent coupon did not appear in need of a whole lot of correction.The bondholder gets

20、it in cashThere is another major difference between the garden variety of bond and our new exotic 12 percent equity bond that comes to the Wall Street costume ball dressed in a stock certificate.In the usual case, a bond investor receives his entire coupon in cash and is left to reinvest it as best

21、he can. Our stock investors equity coupon, in contrast, is partially retained by the company and is reinvested at whatever rates the company happens to be earning. In other words, going back to our corporate universe, part of the 12 percent earned annually is paid out in dividends and the balance is

22、 put right back into the universe to earn 12 percent also.The good old daysThis characteristic of stocks - the reinvestment of part of the coupon - can be good or bad news, depending on the relative attractiveness of that 12 percent. The news was very good indeed in, the 1950s and early 1960s. With

23、bonds yielding only 3 or 4 percent, the right to reinvest automatically a portion of the equity coupon at 12 percent via s of enormous value. Note that investors could not just invest their own money and get that 12 percent return. Stock prices in this period ranged far above book value, and investo

24、rs were prevented by the premium prices they had to pay from directly extracting out of the underlying corporate universe whatever rate that universe was earning. You cant pay far above par for a 12 percent bond and earn 12 percent for yourself.But on their retained earnings, investors could earn 22

25、 percent. In effert, earnings retention allowed investots to buy at book value part of an enterprise that, :in the economic environment than existing, was worth a great deal more than book value.It was a situation that left very little to be said for cash dividends and a lot to be said for earnings

26、retention. Indeed, the more money that investors thought likely to be reinvested at the 12 percent rate, the more valuable they considered their reinvestment privilege, and the more they were willing to pay for it. In the early 1960s, investors eagerly paid top-scale prices for electric utilities si

27、tuated in growth areas, knowing that these companies had the ability to reinvest very large proportions of their earnings. Utilities whose operating environment dictated a larger cash payout rated lower prices.If, during this period, a high-grade, noncallable, long-term bond with a 12 percent coupon

28、 had existed, it would have sold far above par. And if it were a bond with a f urther unusual characteristic - which was that most of the coupon payments could be automatically reinvested at par in similar bonds - the issue would have commanded an even greater premium. In essence, growth stocks reta

29、ining most of their earnings represented just such a security. When their reinvestment rate on the added equity capital was 12 percent while interest rates generally were around 4 percent, investors became very happy - and, of course, they paid happy prices.Heading for the exitsLooking back, stock i

30、nvestors can think of themselves in the 1946-56 period as having been ladled a truly bountiful triple dip. First, they were the beneficiaries of an underlying corporate return on equity that was far above prevailing interest rates. Second, a significant portion of that return was reinvested for them

31、 at rates that were otherwise unattainable. And third, they were afforded an escalating appraisal of underlying equity capital as the first two benefits became widely recognized. This third dip meant that, on top of the basic 12 percent or so earned by corporations on their equity capital, investors

32、 were receiving a bonus as the Dow Jones industrials increased in price from 138 percent book value in 1946 to 220 percent in 1966, Such a marking-up process temporarily allowed investors to achieve a return that exceeded the inherent earning power of the enterprises in which they had invested.This heaven-on-earth situation finally was discovered in the mid-1960s by many major investing institutions. But just as these financial elephants began trampling on one another in their rush to equities, we entered an era o