How do you invest and still make a profit when inflation is up to a 40-year high? Let’s seek advice from Warren Buffett Charlie Munger & Mohnish Pabrai.
Inflation is on the Rise!
“It’s the biggest long-range danger we have probably apart from a nuclear war.” — Charlie Munger
We’re currently seeing record levels of inflation, in fact, the latest inflation data came out in the US and it’s yet another 40-year high this time close to 9%. When inflation gets really high like this, the federal reserve raises interest rates to put the brakes on the economy. Fed’s last announcement of a 0.75% interest rate hike could be just the start.
How to Invest and Profit from Inflation?
Businesses take out loans, too debt becomes more expensive, and if you couple that with consumers that no longer have a lot of spare money to buy iPhones and Netflix subscriptions because now they’re so focused on paying down their mortgage and their credit cards, all of a sudden sales drop at these businesses and stock prices fall. So the question is how do we, as stock market investors, best protect ourselves from suffering at the hands of inflation.
Let’s dive in!
1. Look for Companies with Pricing Power
The businesses that will perform the best are the ones that require little capital investment to facilitate inflationary growth, that have strong positions, that allow them to increase prices with inflation. Companies that have pricing power have some form of strong competitive advantage — an intrinsic characteristic of their business that sets them apart from their competitors. Costco’s low prices, Amazon’s reach and Facebook’s network.
We have a candy business for example and the value of the dollar, since we bought that candy business has probably fallen at least 85 percent I would say. And that candy business sells 75 percent more pounds of candy than it did when we bought it. But it has 10 times the revenues and it doesn’t take a lot more capital.
– Warren Buffet
So that kind of a business, any business that has enough freedom to price to offset inflation and doesn’t require huge investment to support it will do well. The business has enough power, to raise prices to mitigate the effects of inflation.
When the purchasing power is declining and in economies like India I think, even strong brands serving the middle and lower income classes will be challenged to raise prices. On the other hand, if you’re Louis Vuitton or Ferrari you know you’re at the top end. You will have a very strong ability to raise prices, regardless of inflation because you know the rich are getting richer and you know they’ve got limited places they can spend their money etc.
On the contrary Netflix is a small luxury bought by the masses and they have a competitive advantage. But as consumers whittle away their savings, they may look to cut their subscription spending altogether to save money.
– Mohnish Pabrai
2. Pick Companies that can Leverage past Investments
It’s important to go with businesses doesn’t require a huge amount of capital to support inflationary growth as the cost of capital as well as the CAPEX requirement for investments.
Let’s say, for example, I own a hotel and it’s up and running. If it’s in a good area that the nightly rates might go up in lockstep with inflation because you did the CAPEX in yesterday’s dollars.
Inflation is going to hurt you only if you build the next hotel. But if you are milking the cow on old CAPEX that you’ve done in old dollars, inflation is at your advantage
– Mohnish Pabrai
Since its inception in 1892, Coca-cola has been growing to sell 1.9 billion bottles per day. They have already invested in plants and distribution networks to deliver to the demand. Today, they reap the benefits of those investments made in “yesterday’s dollars”.
3. Avoid Companies that need Fresh Investments to keep up
We’re better off looking for those businesses that do not need huge sums of money to maintain their market share. It’s best to milk the cow without trying to buy more cows as it hurts during high inflation.
Companies that need to invest heavily to maintain their competitive position are the ones that are going to struggle right now. Businesses like our utilities which get in effect, a bond like return but require, you know if you’re going to build a generating plant that costs twice as much per kilowatt-hour of capacity
– Warren Buffet
4. Choose the least bad & concentrate on other assets
Charlie Munger believes high inflationary environments hurt most of the investment returns. So, instead of choosing the best, it may be a time to choose the least bad. Also, he emphasizes the importance of concentrating on international stocks and physical asset classes like real estate.
It may be that you have to choose the least bad out of a bunch of options which frequently happens in human decision-making. The Mungers have Berkshire stock, Costco stock, Chinese stocks Li Lu, a little bit of Daily journal stock, and a bunch of apartment houses.
Do I think that’s perfect? No! Do I think it’s ok? Yes! I think the great lesson from the Mungers is you don’t need this damn diversification; You are lucky if you got 4 good assets.
– Charlie Munger
Let’s Face it!
It’s evident that a high inflationary environment is going to hurt many investors. And investors need to be prepared and adjust right. The most important thing is adjusting one’s expectations. You don’t want to be speculating and chasing higher returns of yesteryear. Make sure that your emergency funds are ready. You don’t want to be investing money that might need to cover up expenses across the next few years.
What are your thoughts? Let me know in the comments below! If you enjoyed this article, please share it and follow for more content like this. Thank you for reading! Part of this content is inspired by the works of NewMoney youtube channel.
Note: Please note that this is not investment advice, the information given above is presented for financial education purposes only.
Written by Lilan Priyashantha