Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 2 – The Investor and Inflation – of the Intelligent Investor written by Benjamin Graham.
- What quote from this chapter do you think best summarizes the point Graham is making?
Stocks, as other asset classes, will be affected by inflation. Graham states, which I think is essential for any investor to remember, that “…the possibility of large-scale inflation remains, and the investor must carry some insurance against it. There is no certainty that a stock component will insure adequately against such inflation, but it should carry more protection than the bond component.”
- What projection do you have for the inflation rate going forward?
In general I think that the inflation rate going forward will be higher (the question being “How high?) than it has been during the last 5 to 7 years. The financial crisis has kept inflation at a low level. At the same time we have seen large interventions made by central banks around the world. Any projection made should take into account that the future inflation rate will probably not be the same as in the last 5 to 10 year period. Maybe I should have a better grasp, but at the moment I don’t. I focus on buying businesses that I think, in some way, can protect themselves against inflation – see question four below.
- Why do you think that some people choose to ignore inflation when making financial decisions?
Most people don’t have a long-term horizon when it comes to buying stocks, they’re in it for the short-term – i.e. more kind of speculators than investors. That’s the main reason why I think inflation is not a big issue for them. For someone only in it for the short run the issue about inflation won’t be as important to them compared to someone who’s to buy and hold for 10 to 15 years.
- How do you hedge your portfolio against inflation?
I try to hedge against inflation by buying great businesses with high and stable cash flows, low capex requirements, financially strength and pricing power. Inflation is one aspect in my investment analysis and when I look at a business I try to understand how it will be affected by inflation. Is the business asset heavy, i.e., a lot of fixed assets needed to run the business, high capex requirements etc. I also look at the expense structure of the business, competitors, industry, and then I try make a reasonable assumption as to whether the business will be able to pass on higher future input costs to customers?