Jim, you frequently make your projections for Berkshire’s gains in intrinsic value as X% plus inflation.
Many (most?) business’ value fails to keep pace with inflation, which makes inflation so brutal to investors.
As detailed in many of Buffett’s writings, particularly well in How Inflation Swindles The Equity Investor.
So I would be very appreciative if you could give your rationale as to why this seems like such an automatic feature of Berkshire. Thanks.
It’s nothing special about Berkshire.
First, you have to carve out the situation that inflation is so high that the economy simply breaks.
A broken economy is not good for any company.
We are not in that situation today.
Ignoring those rare situations, the average company’s earnings do keep up with inflation almost perfectly.
If all wages, supplies, energy, prices, revenues all rise by the same amount, so will gross margins and net profits.
This will hit different firms to differing degrees, and with different time lags.
It will hit firms with a lot of debt differently from firms with positive net currency-denominated assets.
And it will hit different firms depending on their sensitivity to the things that are rising in price faster or slower than the overall average.
But overall across the corporate sector, inflation (without a broken economy) is not a problem for real company earnings.
Neither theoretically nor empirically.
For Berkshire it’s probably more true than for most forms, simply because Berkshire is so diversified.
One division will be hit hard by (say) rising petrochemical input prices to make carpets,
but another will do particularly well because prices are rising faster than costs in some areas.
The latter aren’t always obvious, but it is the inevitable other half of the average price rise.
That latter is sometimes a bit dark from a societal point of view, since it sometimes comes from falling real wages.
From the recent peak 2020-Q2 to 2022-Q2, median usual weekly real wages in the US have fallen 8.9%.
A bummer for those employees, but a windfall for their employers who have raised their product/service prices in line with inflation or more.
Inflation certainly messes with bookkeeping in an annoying way.
It also messes with real tax rates a little bit at the margin.
0% T-bills at 0% inflation get 0% tax, but 3% T-bills at 3% inflation, the same real rate, get 0.63% tax.
But in terms of real owner earnings across the economy, inflation is just one more flavour of squiggle that disappears in the noise over time.
So, the answer to why I’m sanguine in the face of the observation that many/most firms’ profits don’t keep up with inflation–
it’s because they do : )
It’s not that I don’t worry about macro effects on long run trend real profits.
As the capitalists we are, I would be much more concerned about the corporate profit shares of GDP, relative to labour and tax, in the next 15 years.
It has been a golden age recently. Golden ages don’t usually last forever.
From 1951 to 2004 US corporate profits never got above 8.5% of US GDP, averaging just under 6.1%.
It has been mostly in the range 9% to 11.5% since the credit crunch, averaging just over 10%.
https://fred.stlouisfed.org/graph/?g=1Pik
If that average figure falls, Berkshire’s very diversification will suggest that our profitability will fall just as much.
If the old norms returned, profits could fall by 30-40% and stay that low as a percentage of revenue forever.
That’s not a prediction, but one should probably be prepared for some unknown fraction of it to become true.
For Berkshire, or for any broad US equity portfolio.
Jim