Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Inflation - Your friend or enemy? - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Jul 20, 2009

    Inflation - Your friend or enemy?

    When you are in the stock market buying stocks for the long run, the above can be quite a tricky question to answer. That is because how much damage inflation does to you depends a lot on what kind of business you are invested in. There are many aspects that go into determining whether a particular business is a good or a bad investment. But looking at it from the perspective of inflation, one important factor one can look at is what kind of returns the company makes on the tangible assets employed in the business.

    In its simplest form, when anyone starts a business, one has to invest in tangible assets that will be used to run the operations of the company. Tangible assets are those assets of the company that can be touched, seen and felt, like buildings, machinery, inventory, cash, furniture etc.

    If you get into the cement business, you would have to buy cement plants to make the cement that you can sell. If you get into the chocolate business, you would have to buy the plants and equipment that makes chocolate. So you buy all the assets needed to make the cement or the chocolate, start selling them, and are happy with the profits either business is earning you. But it is a fact that all businesses are not made equal. Depending on many different factors, some businesses are more profitable than others. And one way of measuring the profitability of the business is its return the tangible assets invested in the business.

    Going forward with our earlier example, let's assume that the cement business is able to achieve, on an average, return on tangible assets of 10%, and the chocolate business of 25%. So, the cement business earns net profits of Rs 1 m on Rs 10m of tangible assets, and the chocolate business - Rs 1 m on Rs 4 m of tangible assets. All assets undergo wear and tear, and therefore, after their useful life is over, have to be replaced with new assets. Say for example the life of the plants of both the businesses is 10 years, and in that time prices of everything triple due to heavy inflation.

    Going by that, the profits of the two businesses will also triple (assuming the businesses sell the same number of units and have the same margins ten years later), as the prices of cement and chocolate also triple during the time.

    But now that the life of their plants and equipment is over, and the time comes for them to be replaced, the chocolate business has to buy the new plant for 4 x 3 = Rs 12 m. Thus to maintain the same level of business, the chocolate company will have to invest Rs 12 m 10 years later. But what about the cement company? To achieve the same level of profits as the chocolate business 10 years later (of Rs 4 m), it will have to invest 10 x 3 = Rs 30 m!

    As the years go by, and governments around the world keep printing money for humungous bailouts and stimulus packages, inflation is almost sure to be one of our biggest enemies going forward. But the above article shows how by choosing the right kind of business to be invested in, one can to some extent lessen the damage inflation does. So the next time you pick up an annual report of a company you own, add up all its tangible assets, divide its net profits for the year by the tangible assets of the company, and see what kind of returns its earns on them. Then compare it to the similar result of another company, and you will know which of those companies will be able to better protect you from the harmful effects of inflation in the years to come.



    Equitymaster requests your view! Post a comment on "Inflation - Your friend or enemy?". Click here!


    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    You've Heard of Timeless Books... Ever Heard of Timeless Stocks? (The 5 Minute Wrapup)

    Aug 19, 2017

    Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.

    Why NOW Is the WORST Time for Index Investing (The 5 Minute Wrapup)

    Aug 18, 2017

    Buying the index now will hardly help make money in stocks even in ten years.

    Trump Takes a Beating (Vivek Kaul's Diary)

    Aug 18, 2017

    Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.

    How To Read Your Mutual Fund Account Statement Correctly (Outside View)

    Aug 17, 2017

    PersonalFN simplifies the mutual fund account statement for you.

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms


    Aug 18, 2017 (Close)