Inflation-proof investments

Table of Contents

Inflation is the most lethal

In his letter to shareholders in 1980, Buffett explained the huge killing power of inflation to investors with examples:

In a world of 12% inflation a business earning 20% on equity (which very few manage consistently to do) and distributing it all to individuals in the 50% bracket is chewing up their real capital, not enhancing it. (Half of the 20% will go for income tax; the remaining 10% leaves the owners of the business with only 98% of the purchasing power they possessed at the start of the year – even though they have not spent a penny of their “earnings”). The investors in this bracket would actually be better off with a combination of stable prices and corporate earnings on equity capital of only a few per cent.

Explicit income taxes alone, unaccompanied by any implicit inflation tax, never can turn a positive corporate return into a negative owner return. (Even if there were 90% personal income tax rates on both dividends and capital gains, some real income would be left for the owner at a zero inflation rate.) But the inflation tax is not limited by reported income.

Inflation rates not far from those recently experienced can turn the level of positive returns achieved by a majority of corporations into negative returns for all owners, including those not required to pay explicit taxes. (For example, if inflation reached 16%, owners of the 60% plus of corporate America earning less than this rate of return would be realizing a negative real return – even if income taxes on dividends and capital gains were eliminated.)

Inflation resistant companies

For Buffett, who has been investing in stocks for 80 years, severe inflation and economic fluctuations are not new. Selecting companies that can stand out under inflation is an indispensable factor in Buffett’s investment technique.

In a 1981 letter to Berkshire shareholders, Buffett highlighted two characteristics that make a business well adapted to an inflationary environment:

An ability to increase prices easily . (Note: That is, the moat with the “power to increase prices”)
An ability to take on more business without having to spend too much in order to do it. (Note: Wall Street regards such companies as “asset-light” companies)

In response to the latter, in the 1983 Berkshire shareholder letter, he further added that he prefers companies with more intangible fixed assets. A company with a lot of tangible fixed assets refers to a company that owns a lot of equipment. Equipment investment is often linked to inflation, which is easy to expand and squeezes profit margins.

Typical stocks in Buffett’s portfolio

Buffett’s Apple (ticker: AAPL), which accounts for about 40% of the total market value of listed stocks in Berkshire’s investment portfolio, Coca-Cola (ticker: KO), which has been held for a long time since the 1980s, American Express (ticker: AXP), and the media stocks that will be increased in 2022 are all A typical case that meets the two conditions mentioned above.

In the 2022 Berkshire shareholder letter, he emphasized that he was not picking stocks: focusing on long-term holdings, he was picking a business to invest in, ignoring short-term inflation and other issues. Moreover, the compound interest effect of dividends plus time, taking Coca-Cola and American Express as examples, illustrates the long-term returns brought by successful investments, and says that “At Berkshire, there will be no finish line.”

“In August 1994 – yes, 1994 – Berkshire completed its seven-year purchase of the 400 million shares of Coca-Cola we now own. The total cost was $1.3 billion – then a very meaningful sum at Berkshire.

The cash dividend we received from Coke in 1994 was $75 million. By 2022, the dividend had increased to $704 million. Growth occurred every year, just as certain as birthdays. All Charlie and I were required to do was cash Coke’s quarterly dividend checks. We expect that those checks are highly likely to grow.”

“Berkshire also offers some modest protection from runaway inflation, but this
attribute is far from perfect.”

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