Eaglestone Capital
“…the top year in our company’s history…”
-Sam Walton 1972 Wal-Mart Annual Report
“… with interest rates on passive investments at late 1981 levels, a typical American business is no longer worth 100 cents on the dollar ... inflation acts as a gigantic corporate tapeworm. That tapeworm preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism.”
- Warren E. Buffett, 1981 Berkshire Hathaway Annual Letter
Let’s Revisit the 1970s - the Inflationary Years (December 1972 to December 1981)
Inflation is probably the most often discussed financial issue in 2024: why does it persist, how does it affect rates and how will inflation and higher rates affect our investments.
As measured by the Consumer Price Index (CPI) in May 2024, US inflation remains elevated at 3.4% while short term T-bills yield 5.25%, the 10 year treasury yields 4.55% and the 30 year mortgage rate remains elevated over 7%. If inflation and rates remain elevated will investment valuations inevitably decline?
Wal-Mart Stores, Inc.
The 1970’s provides some insight. In the late 1960’s and early 1970’s McDonald’s Corporation and Wal-Mart were members of the ‘Nifty Fifty’ - a group of highly regarded growth stocks that propelled the bull market of that era. Unfortunately, as inflation rose above 3.6% in December 1972 to a peak of 14.5% in April 1980 the 10 year treasury yield rose from 6.4% in December 1972 to 14% in December 1981 once favored growth stocks McDonald’s and Wal-Mart saw their valuations fall from P/E multiples of 81x (McDonald’s) and 48x (Wal-Mart) to 10x (McDonald’s) and 17x (Wal-Mart), limiting the benefits of strong EPS growth on their share prices.
Investors flocked to treasuries because of the 14% yields while few stocks performed well during this period. Bucking this trend, a quality stock like Wal-Mart’s rose at a CAGR of 19.6% per year over this period - Wal-Mart was consistently growing same store sales each year between 11% to 15% while earning returns on capital employed across both their existing and new stores of over 30% per year, far exceeding the 14% cost of capital implied by the 10 year treasury yield.