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Why subtract inflation from cash but not earnings? You have to subtract from both. 20 PE in 8% inflation environment implies -3% return, ignoring growth. Howe

Why subtract inflation from cash but not earnings? You have to subtract from both. 20 PE in 8% inflation environment implies -3% return, ignoring growth. However people tend to refer to the 10y breakeven rate for forward inflation expectations as CPI is backwards looking. Forward long term inflation expectations are around 3% atm, per the bond market. And the reason -3% is preferable sometimes, is because you would have lost 70% buying NFLX a few months ago. Overvalued companies aren't a very good inflation hedge when discount rates increase dramatically, despite the common narrative

reducesuffering 5y ago
Say a co. is $1b market cap and earned $50m last year. 20 P/E, but 8% inflation means that $50m is now worth last years $46m real. So the company has an extra 4.6% value in the bank but also, because inflation they’re earning $54m next year, the same real value. So by a 20 P/E, they’re worth $1.08b now because inflation ate away the dollar. So you’ve gained 8% nominal, 0% real, but also 4.6% real. Meanwhile $1b in the bank is still $1b but now worth $920m, so -8% real. That’s why you subtract inflation from cash but stock assets are mostly inflation resistant. People can tend to do whatever they want, it doesn’t make it correct. Last year, the 10y was like 1.2% while inflation turned out to be 8.5%. Clearly the 10y is not a good reliable indicator of inflation. Ya -3% can be preferable to a stock going down 70%. But that’s not the reason to own stock assets. You could of also owned Netflix from 2019 to 2021 and been up 250%. What matters is the true value of future expected earnings of the company, compared to what the value is now. By my estimation, Netflix is trading well below those future earnings in this inflationary environment, even with hefty interest rate hikes that bring inflation down, simultaneously shrinking stock premiums from both sides. I wouldn’t be surprised if Berkshire bought in at this level.
- adam_arthur 5y ago
  Not sure what the long comment is about. It's basic and correct math that you subtract inflation from yield of a bond or stock, just as you would cash in a bank. Equities are not immune to inflation as you say. Inflation affects different companies in different ways, and also leads to higher discount rates which hurts longer duration and higher multiple assets the most. The nature of the inflation matters too. Only wage inflation is generally good for earnings, unless you're a commodity provider. Consumer spending power declines with anything that's not wage inflation An overvalued stock is a worse inflation hedge than cash in a rising discount rate environment. Netflix could be a good investment, or it could be terrible if its earnings start to decline. A company with declining earnings is even worse than a bond of the same yield
  - reducesuffering 5y ago
    What you’re entirely missing is that stocks track inflation (and exceed it with growth) long term. Yes, for past returns, nominal yield - inflation is all there is to calculate real yield. But using that to project future yield, without factoring in inflation’s future effect on the asset, is a mistake, as my math illustrates. If you have a bond paying 5%, and a stock paying 5% yield, but the government suddenly prints 10% of money to the money supply and helicopter moneys it, that bond won’t budge, it’s why it’s called fixed income, the future payments are already set nominally. But that stock would effectively be worth 10% more, because the currency was debased 10%. There’s the same amount of company ownership producing tangible goods now being chased by 110% of the money. Yes, fluctuations from CPI occur due to front loading expectations, velocity, potential from M2, interest rates, productivity growth, and macroeconomic environment. All those are different forces applying pressure at various times, but they’re orthogonal to limited company ownership chased by an inflating currency. It’s much more certain that company value be retained independent on inflation than the 10y will predict it.

reducesuffering 5y ago

Say a co. is $1b market cap and earned $50m last year. 20 P/E, but 8% inflation means that $50m is now worth last years $46m real. So the company has an extra 4.6% value in the bank but also, because inflation they’re earning $54m next year, the same real value. So by a 20 P/E, they’re worth $1.08b now because inflation ate away the dollar. So you’ve gained 8% nominal, 0% real, but also 4.6% real. Meanwhile $1b in the bank is still $1b but now worth $920m, so -8% real. That’s why you subtract inflation from cash but stock assets are mostly inflation resistant. People can tend to do whatever they want, it doesn’t make it correct. Last year, the 10y was like 1.2% while inflation turned out to be 8.5%. Clearly the 10y is not a good reliable indicator of inflation. Ya -3% can be preferable to a stock going down 70%. But that’s not the reason to own stock assets. You could of also owned Netflix from 2019 to 2021 and been up 250%. What matters is the true value of future expected earnings of the company, compared to what the value is now. By my estimation, Netflix is trading well below those future earnings in this inflationary environment, even with hefty interest rate hikes that bring inflation down, simultaneously shrinking stock premiums from both sides. I wouldn’t be surprised if Berkshire bought in at this level.

adam_arthur 5y ago
Not sure what the long comment is about. It's basic and correct math that you subtract inflation from yield of a bond or stock, just as you would cash in a bank. Equities are not immune to inflation as you say. Inflation affects different companies in different ways, and also leads to higher discount rates which hurts longer duration and higher multiple assets the most. The nature of the inflation matters too. Only wage inflation is generally good for earnings, unless you're a commodity provider. Consumer spending power declines with anything that's not wage inflation An overvalued stock is a worse inflation hedge than cash in a rising discount rate environment. Netflix could be a good investment, or it could be terrible if its earnings start to decline. A company with declining earnings is even worse than a bond of the same yield
- reducesuffering 5y ago
  What you’re entirely missing is that stocks track inflation (and exceed it with growth) long term. Yes, for past returns, nominal yield - inflation is all there is to calculate real yield. But using that to project future yield, without factoring in inflation’s future effect on the asset, is a mistake, as my math illustrates. If you have a bond paying 5%, and a stock paying 5% yield, but the government suddenly prints 10% of money to the money supply and helicopter moneys it, that bond won’t budge, it’s why it’s called fixed income, the future payments are already set nominally. But that stock would effectively be worth 10% more, because the currency was debased 10%. There’s the same amount of company ownership producing tangible goods now being chased by 110% of the money. Yes, fluctuations from CPI occur due to front loading expectations, velocity, potential from M2, interest rates, productivity growth, and macroeconomic environment. All those are different forces applying pressure at various times, but they’re orthogonal to limited company ownership chased by an inflating currency. It’s much more certain that company value be retained independent on inflation than the 10y will predict it.