Equities have given almost fixed return: Warren Buffet

Oracle of Omaha explains how the returns on equities in long run have been around 12% in post war era. In an article by Mr. Buffet, he explains lot more things on how inflation has taken away with investors wealth.

It is no longer a secret that stocks, like bonds, do poorly in an inflationary environment. We have been in such an environment for most of the past decade, and it has indeed been a time of troubles for stocks. But the reasons for the stock market’s problems in this period are still imperfectly understood.

There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner. You hardly need a Ph.D. in economics to figure that one out.

It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might.

In the first 10 years after the war — the decade ending in 1955 — the Dow Jones industrials had an average annual return on year-end equity of 12.8%. In the second decade, the figure was 10.1%. In the third decade it was 10.9%. Data for a larger universe, the Fortune 500 (whose history goes back only to the mid-1950s), indicate somewhat similar results: 11.2% in the decade ending in 1965, 11.8% in the decade through 1975. The figures for a few exceptional years have been substantially higher (the high for the 500 was 14.1% in 1974) or lower (9.5% in 1958 and 1970), but over the years, and in the aggregate, the return in book value tends to keep coming back to a level around 12%. It shows no signs of exceeding that level significantly in inflationary years (or in years of stable prices, for that matter).

For the moment, let’s think of those companies, not as listed stocks, but as productive enterprises. Let’s also assume that the owners of those enterprises had acquired them at book value. In that case, their own return would have been around 12% too. And because the return has been so consistent, it seems reasonable to think of it as an "equity coupon."

In the real world, of course, investors in stocks don’t just buy and hold. Instead, many try to outwit their fellow investors in order to maximize their own proportions of corporate earnings. This thrashing about, obviously fruitless in aggregate, has no impact on the equity coupon but reduces the investor’s portion of it, because he incurs substantial frictional costs, such as advisory fees and brokerage charges. Throw in an active options market, which adds nothing to the productivity of American enterprise but requires a cast of thousands to man the casino, and frictional costs rise further.

Hitesh Anand

I am a post graduate from Newcastle University, UK. I like studying and analyzing economic data and financial health of world.

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