Inflation And ValueThe Acquirer's Multiple
During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Inflation And Value. Here’s an excerpt from the episode:
Tobias: Yeah, I’ll take a shot at it. So, we’ve had this massive crash. We’ve been printing pretty hard, globally, the central banks, Bank of Japan, the European Central Bank, ECB, and the Fed and all the other little ones, the Aussie– Australia has a central bank, and they’re out there doing their best as well. In some, we’ve printed this gigantic amount of money, starting a long, long time ago. We really, really turned it up in about 2010. And we’ve really taken the– we’ve set them to 24-hour printing as of earlier this year, seems to be that at some stage if you print a whole lot of money that turns up. Apparently, you’re not allowed to say that inflation runs through asset prices, but I think that inflation has probably pretty clearly run through asset prices for the last decade or so.
I think it’s probably run through consumer prices as well. But I don’t think that’s been really well picked up by the CPI, which is always adjusted to reduce the amount of inflation that you see. And somehow, they get the benefit of when you get a better television, you hedonically adjust the better TV, better computer, better car, so on. I think we’re probably likely to see some inflation in the future. And that might be a mild understatement to say that we’re going to see some, we might see a lot.
Jake: What would a lot be, Toby, for you?
Tobias: Well, I mean, I think that we see something like a 70s style stagflation, where– interest rates are pinned pretty close to zero at the moment. And central banks can’t do anything about it. The reason that they’re pinned at zero is that government’s got way too much debt. The average consumer’s got way too much debt. The average company’s got way too much debt. If interest rates go up, none of us can afford it. So, interest rates are going to be pinned at zero for a long time. So, there’s no way to deal with any inflation if we get any. And then, on top of that, we’re printing a whole lot of money. The idea, I guess, was that you don’t see the asset price inflation. We’ve had this collapse. We’ve papered over the top of it. And we’ve got no way to deal with it because interest rates are going to be pinned at zero. It just seems to me that the only place where that can blow out in that system is through a whole lot of inflation. So then, what do you do in an inflationary environment?
This is kind of one of the really difficult topics to deal with because in an inflationary environment, low asset-light businesses should do better. So, Buffett talks about this quite a lot in his letters, where he said, “You don’t want a business that’s got a lot of heavy assets in it that need to be maintained and grown.” The only way that company can grow is by reinvesting in its assets and they do so at increasingly high prices. So, on an after-tax, after-inflation basis, it becomes extremely hard to make any money in this market.
There’s a theory going around, and I don’t know if it’s true or not, it’s something that I would like to believe, but that inflation will help value stocks, something to do with the duration trade where that nearer term cash flows become more important than the cash flows that further out. But then, I’ve also got to bear in mind, Buffett’s thinking about low asset intensity, businesses tending to do better well that can maintain pricing power, that’s very important.
In that scenario, it sounds to me like Buffett would favor more of a FANMAG-type portfolio, assuming that he can get the right price, rather than deeper value energy banks, heavy industrials type portfolio, but that sounds more like a value portfolio. So, I think it’s an extremely difficult time to be investing in this market. It looks like you want to be in the asset-light compounders, but then you’ve got to pay extremely high prices for the asset like compounders value, which is been left behind, looks pretty beaten up. But then, that might run really badly through a really high inflationary period. The only thing that I think justifies that is we’re already at that point where perhaps the market has seen that coming and so, the market, with none of us individually knowing that it was going to come, has sort of adjusted itself so that these asset-light compounders are overvalued or are expensive, because that’s where the returns have been and they can deal with inflation, and all the stuff that’s going to struggle with inflation is already very cheap.
In short, I’m confused, and I’m scared.
Jake: [chuckles] Well, if you weren’t confused, you wouldn’t know what’s going on. I agree. I mean, I think it’s incredibly difficult to untangle all these different moving pieces because there’s some where it seems like that would hurt, some where it would help. You don’t know the magnitude of the impact. Yeah, I mean, you raise– if rates go up at all, that seems one of those good outcomes for a value basket potentially for all the same reasons that you said. But, yeah, if it’s high capex, expensive capex, replacing capital to keep the cash flows coming, those businesses do relatively poorly.
Now, I’m not so sure, like– now about this pricing power idea. I think there’s more pricing power in the world when credit creation is on steroids because you’re just like, “Well, I’m just going to borrow the money.” But if you actually had to come up with the cash, you might be a little less willing to pay the vendor, you might drive a little harder bargain. Everyone’s looking to chisel a little bit harder on everyone else. Maybe there’s not as much pricing power out there, as everyone assumes.
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