5 ways to improve company earning

Table of Contents

Origin of this article

On inflation (side topic earning), Buffett wrote a legend article in Fortune Magazine in 1977 as “Buffett: How inflation swindles the equity investor.“

Article focus

The abstract of the article is as follows:

In inflation, bond investors will suffer significant losses, while stock investors will not fare much better.
The analysis ideas for stocks are similar to those for bonds.
In a low-inflation environment, the return on equity of stocks is more attractive than the return on bonds. Investors gain the following triple benefits in a low-inflation environment:

(1) The company’s return on net assets is much greater than the benchmark interest rate;

(2) The undistributed profits attributed to investors continue to remain within the company, and this part can obtain a return equivalent to the return on net assets;

(3) As interest rates continue to fall, stock valuations increase.

Investors require a higher return on equity than bonds, but in fact, considering five methods to increase the return on equity of stocks, Buffett found that the return on equity of stocks has not improved in an inflationary environment.
Under the same ROE, the earnings quality of low-leverage companies is much better than that of high-leverage companies.
The vast majority of companies do not have the ability to pass on costs and expand or maintain profit margins under inflation.
Under inflation, low valuations serve as a protection for value investors.
Peacetime inflation is more a political than an economic problem. No one can accurately predict inflation. But Buffett does believe that inflation will remain high in the next few years.
Inflation is an invisible tax. Even for stock investors, under high inflation, the actual purchasing power decreases.
The best way for individuals to deal with high inflation is to improve their bargaining power.
“Robbing the rich and giving to the poor” cannot provide even temporary help to the poor. The correct approach is to guide capital to invest in modern productivity and improve economic productivity.
High inflation raises the cost of capital expenditures by companies, thereby inhibiting their ability to reward shareholders.
Under high inflation, the government often intervenes in capital to stimulate capital flows to the industrial sector.

5 ways to improve company’s earning

Is the 12% yield on this equity bond destined to remain static? Is there a law prohibiting companies from increasing their return on equity in response to inflation that seems to be ever-increasing?

Of course, this law does not exist. But on the other hand, U.S. corporate earnings cannot be set by expectations and government mandates.

In order to increase ROE, a company must do one of the following:

Improve turnover rates. For example, the turnover rate of sales and total assets is used within the enterprise;
Cheaper leverage;
More leverage;
Lower income taxes;
Higher profit margins.

That’s all, there should be no other way to increase ROE.

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