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well inflation it's a really hot topic right now we've seen the fed saying this inflation we're seeing now is short term you know nothing to worry about then on the other hand we've seen warren buffett talking about how he's seeing big inflation throughout berkshire hathaway's businesses we've got michael bury making a new big short on bonds so it's something to watch for sure but how does it actually affect us as investors and what's the best way to negotiate a period of high inflation well in this video we're going to dive into some past annual letters from the world's best investor warren buffett to see how he suggests we go about investing during inflationary periods so as investors what we want to do is commit a certain amount of money to an investment and get more money back at some point the future but when we talk about inflation and investing it's more helpful to think of investing like this we're giving up a certain amount of buying power now in order to have more buying power in the future aka we're giving up the purchasing power to buy a hundred meatball subs now in the hope that we have the purchasing power to buy 150 in the future now when you think about it like that you're thinking about your real return and while you may make say a 20 gain on an investment on paper over a few years if inflation is running rampant there's a potential that your real return is zero you could buy a hundred meatball subs before then you make 20 on your investment then you sell it but after that you can still only buy a hundred meatball subs now you've had no gain in purchasing power this is warren buffett talking to that point in 1979 he said a few years ago a business whose per share net worth compounded at 20 percent annually would have guaranteed its owners a highly successful real investment return now such an outcome seems less certain for the inflation rate coupled with individual tax rates will be the ultimate determinant as to whether our internal operating performance produces successful investment results i.e a reasonable gain in purchasing power from funds committed for you as shareholders just as the original three percent savings bond a five percent pass book savings account or an eight percent us treasury note have in turn been transformed by inflation into financial instruments that chew up rather than enhance purchasing power over their investment lives a business earning 20 on capital can produce a negative real return for its owners under inflationary conditions not much more severe than what presently prevail so this was in 1979 and the inflation rate was 11 so it's crazy that when you think about investments from a purchasing power point of view you know the three percent savings bond the high interest bank accounts and even you know an 8 guaranteed treasury bond obviously we're not getting that now but back then that was still giving investors a loss of purchasing power buffett says the combination the inflation rate plus the percentage of capital that must be paid by the owner to transfer into his own pocket the annual earnings achieved by the business i.e ordinary income tax on dividends and capital gains tax on retained earnings that can be thought of as an investor's misery index when this exceeds the rate of return earned on equity by the business the investor's purchasing power real capital shrinks even though he consumes nothing at all so inflation is a crummy time for investors because when you take into account the rate of inflation or we can think about the annual percentage loss of purchasing power and you couple that with either taxes you have to pay on income received through dividends and the capital tax the capital gains tax you have to pay when you sell then your real return on your investment could be negative even if the business does well in 1980 buffett made this analogy which i really like he said the average tax paying investor is now running up a down escalator whose pace is accelerated to the point where his upward progress is nil but beyond being an investor inflation can be a crappy time for businesses as well obviously inflation eats away at their purchasing power as well now businesses generally need to buy a lot of stuff to keep operating if this stuff is now all of a sudden more expensive they're trapped in a dilemma either they pay the higher price to operate and therefore make less profit or they try and raise the prices and hope that their sales volume doesn't shrink because of it inflation can also put upward pressure on interest rates which can make it harder for companies to access loans or make pre-existing loans more expensive to pay off and this makes it much harder for the investor you and me to pick really great stocks that are going to compound our money over time so what do we do well this is warren buffett's explanation of what type of businesses tend to do well even in periods of high inflation he says such favored business must have two characteristics one an ability to increase prices rather easily even when product demand is flat and capacity is not fully utilized without fear of significant loss of either market share or unit volume and two an ability to accommodate large dollar volume increases in business often produced more by inflation than real growth with only minor additional investment of capital so number one an ability to increase prices and cop no consequences that makes sense right the business is feeling higher costs which hurt their margins so why not push those extra extra costs onto the customer if you can whoa that is ridiculous no company could do that you know people would just go and buy the cheaper product elsewhere ah but not if the company has a moat say you're a small production company you've spent money to train all 50 of your employees to use photoshop and premiere pro and after effects that took time and it took money adobe suddenly says subscriptions now ten dollars more per month cop it and you say that's it let's switch to a cheaper alternative maybe you find a cheaper alternative 20 a month cheaper great but it doesn't have all the same features as what the team's already using plus it's going to cost 200 per employee to train them on the new software not to mention the downtime your business will experience to get that training done and to switch everybody over then you think about the clients oh the clients are already stressing you out they're trying to get their productions finished and at the end of the day it's just not worth switching so what do you do you just pay more you stick with adobe you just pay more or another real world example apple has such a strong brand mode and a strong ecosystem that it's completely normal for them to squeeze a little bit more and a little bit more out of all of their customers each year in 2012 iphone average selling price was just over six hundred dollars at the end of 2018 it was almost 800 i'm sure now it's even higher and that's not even considering the plethora of add-on subscriptions apple will more or less force upon you whether it be apple care or icloud or apple music there's no escape and that's the point so during inflationary times look to the companies with very strong moats that can raise prices without consequences but then secondly you want the business to have an ability to accommodate large dollar volume increases in business with only minor additional investment of capital so if you're not just able to pass on extra costs to the consumer that means that you're going to have to cop those costs which means lower margins so to generate the same or more profit with lower margins well it means you need to be able to increase the amount of business you're doing essentially what buffett is saying here is you want companies that are growing and are also pretty scalable for example a ship building company would struggle on this point it costs a lot to build a big ship you're not going to make huge margins doing it but it's also very hard to increase the number of ships you're churning out each year that would take huge enormous investment you know into new shipyards and it'll be really slow to wind up but then if you consider a company like facebook on the other hand if they aren't able to pass on the extra cost to their customers which are the advertisers they could just choose to bump up the frequency of sponsored posts or of other ads so when you're scrolling instagram you see three ads instead of seeing two and they could do that very very easily and very quickly as well so that's the second characteristic that really helps your business thrive even through periods of inflation ability to ramp up their business so the lower margins actually don't have an impact on the financials but buffett has one more piece of advice for those seeking the best strategy during a time of inflation because sometimes there's just no escaping that stock market investing in these times can be really hard so have a listen to this but given the fact that we're dealing with fairly high levels of inflation in india what would your advice be to people who are investing what should they change what should they do yeah well inflation kane said it many years ago that it's an invisible tax that only one man in a million really understands and it's a tax on people that have had faith in their currency uh that the government's issued that the best protection the best investment against inflation is to improve your own earning power you know your own talents very few people maximize their talents and if you'd if you increase your talents they can't tax it while you're doing it they you know they can't take it away from you so if you if you become more useful in your activities your profession you know doctor lawyer whatever it may be that is the best protection against a currency that might decline at a rapid rate and and uh the best investment passive investment i i think is is a good business if you own an interest in a good business uh you're very likely to maintain purchasing power no matter what happens to the currency in this clip buffett is indirectly acknowledging that it's hard to do well as a stock market investor when inflation just keeps ramping up it's a shitty time and your real return can be zero so probably a better thing to do is invest in yourself up skill so that you can achieve a higher level of income so that your personal buying power doesn't fall make yourself more valuable you know if you can maintain your own personal buying power then once inflation settles you're still going to be in a great position to invest and you'll likely be able to snap up some cheap stocks as well so overall that is how the great man warren buffett hints that we should be investing during inflationary times really it does just come back down to the competitive advantage if your business has a moat and can increase prices and suffer no negative consequences then those businesses they actually come out on top during inflationary periods and the reason they come out on top is unfortunately because everybody else loses so overall it's an annoying time but hopefully that helps you understand a little bit more how to negotiate it as an investor so overall guys i hope you enjoyed the video leave a like on the video if you did enjoy it or if you found it useful i really appreciate it subscribe to the channel as well if you have not done so already a lot of my views come from people that aren't subscribed so if you're still here please feel free subscribe it's of course completely free to do and if you're interested in learning how i go about my investing strategies uh passive investing and active investing then you can check out profitful links to two in-depth courses are down in the description below uh one for obviously passive investing one for active investing uh if you wanna check those out that'd be awesome uh but no stress if you don't want to overall guys thank you very much for watching that is it from me for today and i'll see you guys in the next video
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