Warren Buffett - These assets perform well through periods of high inflation

Key takeaways at the end

""

For years the traditional wisdom – long on tradition, short on wisdom – held that inflation protection was best provided by businesses laden with natural resources, plants and machinery, or other tangible assets [...]. It doesn’t work that way.

Asset-heavy businesses [e.g. some utilities] generally earn low rates of return – rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.

In contrast, a disproportionate number of the great business fortunes built up during the inflationary years arose from ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets. 

1983 Shareholder Letter

...

Such favored business must have two characteristics: (1) 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 (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital. 

1981 Shareholder Letter

...

[Note: In 1980, inflation in the US reached ~14.6% and FED rate reached ~20% levels!]

Certain other companies – think of our regulated utilities, for example – fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. 

2011 Shareholder Letter

...

We have not lost our aversion to long-term bonds. [...] We will become enthused about such securities only when we become enthused about prospects for long-term stability in the purchasing power of money. Bonds are no better than the currency in which they are denominated. While recognizing the possibility that we may be wrong and that present interest rates may adequately compensate for the inflationary risk, we retain a general fear of long-term bonds.

1987 Shareholder Letter

...

Our aversion to long-term bonds relates to our fear that we will see much higher rates of inflation within the next decade. Over time, the behavior of our currency will be determined by the behavior of our legislators. This relationship poses a continuing threat to currency stability – and a corresponding threat to the owners of long-term bonds. 

1986 Shareholder Letter

* Bold emphasis added

""

Key concepts and takeaways:

• Asset-heavy vs. asset-light businesses: Asset-heavy businesses are those that have a lot of tangible assets. Tangible assets are properties, plants, and equipment. These businesses need to invest large amounts in order to maintain their operations and product volumes – so called maintenance capital expenditures. In order to grow volumes, these businesses must invest into additional premises and equipment – so called growth capital expenditures. Both expenditures rise together with inflation. Asset-light businesses (e.g. software companies) do not have such expenditures.

• Fixed-income investments: If you invest $1,000 in a bond, you will receive this $1,000 (and coupons in between) back in x years. Over a long-term investment period, however, purchasing power of those $1,000 will be vastly lower in periods of high inflation. In my experience this large risk is often ignored during search for a “safe” investment.