Warren Buffett: Inflation Swindles Stock Investors

Warren Buffett’s Investing Advice During High Inflation

Buffett’s lessons on how inflation “swindles almost everybody” as the stock market is rejoicing in mid-August 2022 with Consumer Price Index (CPI) Inflation coming off its 40 year highs of 9.1% in June 2022 down to 8.5% in July 2022.

Many stocks are up, including some big tech favorites like Alphabet (GOOGL) and Microsoft (MSFT).

Even though these companies missed earnings expectations, people seem to be piling into popular tech stocks as safe haven stocks and hedges against inflation.

According to the Wall Street Journal, the way higher than average inflation we’re still experiencing is hiding the magnitude of our economic slowdown. Total consumer/household and business spending is either flat or falling, and even grocery store spending is down over the last six months.

So I think what legendary investor Warren Buffett said this year about how inflation is swindling almost everybody is still as relevant today as it was when he first wrote about it 45 years ago in a 1977 Fortune article.

People have become bullish on “cheap” stocks lately because some believe the Federal Reserve will only raise rates by another 1% to 1.5% to a final range of around 3.5% to 3.75% by Spring 2023 before having to cut rates again. Even though stocks have been rallying since some of the June and July lows, this could be a red herring because inflation could still spell some trouble ahead.

This is because if Buffett’s inflation assumptions are “close to correct, disappointing results will occur not because the market falls, but in spite of the fact that the market rises.”

I think we’d be wise to heed Buffett because inflation is definitely a tapeworm, and even high quality businesses like Google and Microsoft have to deploy more capital and retain more earnings just to stay in place as inflation is also like a quicksand.

Responding to a 2022 Berkshire Hathaway shareholder meeting investor question asked by CNBC’s Becky, Buffett still believes that “stocks cannot keep pace with inflation, because companies cannot increase their return on equity” and also that “bonds can swindle the equity investor too.”

As most businesses require some capital to operate, Buffett said “we have forced capital investment to essentially keep in the same place.”

Buffett wrote “on balance, however, new equity flotations and retained earnings guarantee that the equity capital locked up in the corporate system will increase.”

“When prices continuously rise, the “bad” business must retain every nickel that it can. Not because it is attractive as a repository for equity capital, but precisely because it is so unattractive, the low-return business must follow a high retention policy” just to offset the effects of inflation.

As high quality businesses as Alphabet and Microsoft are, even they are increasingly retaining earnings while their Return On Invested Capital (ROIC) rates are decreasing since “inflation acts as a gigantic corporate tapeworm” and “the tapeworm of inflation simply cleans the plate.”

It’s uncanny how Buffett repeated that nobody knows what inflation rates are going to be as he’d also written in 1977 because he wrote, “if you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker—but not your partner.”

He contends that it would be great if real income per capita increased even if real investment returns were zero, but unfortunately the real GDP per capita has only increased by 2.7% from the end of 2019 until the end of 2021, compared to CPI inflation increasing by 4.7% during that same period from 2.3% at the end of 2019. Inflation is outflanking real GDP per capita at an almost 2:1 ratio.

Buffett’s moral of the inflation story is that “the best protection against inflation, though, still is your own personal earning bar. So your skills will not be taken away, and your money may be.”

And while it makes total sense to focus on one’s own earning power, ultimately I’m hoping that we will have opportunities to buy stocks on sale as inflation’s effects continue to play out.

If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.

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