Warren Buffett is arguably one of the most successful and experienced investors alive today. And in the current stock market environment, following his guidance could keep investors on the path to long-term wealth creation.
After all, he’s been through multiple corrections, crashes, and periods of high inflation before, each time coming out richer, amassing a $100bn net worth in the process.
What’s more, the current window of opportunity might be closing. The Office for Budget Responsibility (OBR) recently made a prediction that the UK economy will recover to pre-pandemic levels by 2024. And inflation is expected to drop from 10.1% to 2.9% by the end of this year.
With that in mind, let’s take a look at Buffett’s strategy for inflation investing to capitalise on the momentum of the seemingly-looming recovery.
He loves cash
In small amounts, inflation can help stimulate economic growth. But when inflation is too high, the cost of everything begins to climb. This is reflected in rising electricity, gas, food, mortgage bills and other expenses for consumers. For businesses, it emerges in areas like raw materials, manufacturing, and logistical costs.
As household budgets and profit margins get tighter, achieving growth becomes challenging. And for firms lacking robust cash flows, seeking external financing often becomes necessary. The only problem is that with rising interest rates, debt is becoming increasingly expensive. And with stock prices tanking, raising money through equity is hardly ideal either.
That’s why Buffett always seeks out companies that generate plenty of excess cash from operations. Even an unprofitable enterprise that generates positive free cash flow can be financially independent. Moreover, corporations with plenty of money can often steal market share from their struggling competitors, leading to far superior long-term returns for shareholders.
Inflation vs pricing power
To mitigate the impact of inflation, companies almost always try to pass on the increased cost to customers. But not every business has the pricing power to do so. For those lacking brand loyalty, or having low switching costs, price hikes are often dictated by what competitors are doing. And that can make raising prices quite challenging.
So it’s no surprise that Buffett loves companies that have the power to set their own prices without risking losing custom to rivals. It’s no accident that Apple, a company with bucketloads of pricing power, is the largest position in Berkshire Hathaway’s investment portfolio.
Taking a step back
When it comes to investing, there are never any guarantees. Some of the best businesses in the world have seen their valuations slashed in the last 12 months. And this downward momentum may continue, even in portfolios using Buffett’s inflation investing strategy.
However, while there are other factors to consider, excess cash flow and pricing power are two traits proven to improve the odds of achieving long-term success. And when combined with clever tricks like diversification and pound-cost averaging, investors can capitalise on the recent volatility while keeping risk in check.
