4 minute read
Great businesses to PARK YOUR MONEY
Inflation in Namibia has averaged ± 6% over the long term, which means that after 12 years you will only be able to buy 50% of what you were able to buy previously. Surprised? This is in a normal environment. What if inflation is even higher for a while?
The biggest question on investors’ lips is whether the tsunami of stimulus (money creation by central banks) will result in above average inflation. Why is this important? Traditionally, central banks raise interest rates to curb inflation when the economy becomes too hot. If inflation is above average, it could mean that interest rates need to rise. The problem is that many countries have so much debt that they are not able to afford a rise in interest rates. This could mean that central banks might be forced to allow inflation to run its course, which could seriously reduce people’s purchasing power (your money’s worth becomes less). This potential for inflation has caused many investors to scratch their heads trying to figure out where to park their funds. So, yes, sometimes it is not only hard to make money, but also difficult to know where to park that money.
In a potential world with above-average inflation and lower growth, one of the places to invest in are businesses. However, not all businesses. Which ones are suitable?
Let’s look at a simple income statement:
• Sales (of goods and services)
• Costs (to produce those goods and services)
• Tax
• Profit after tax
If inflation rises, there is a strong possibility that the costs of the goods (or services) that you produce or sell will go up. All else being equal, this would mean that your profit drops. You could try to increase the price of the goods or services that you sell, but there is a chance that the volume of goods or services will decrease and, as a consequence, also reduce your profits.
Certain types of businesses have the ability to increase prices without it having an effect on their sales. Let us assume that you are the manufacturer of very specialised and critical braking systems for aeroplanes. These braking systems may be a fraction of what it costs to build an aeroplane, and given that it is business critical, the aeroplane manufacturer might not make a big fuss if the “braking systems business” passes through inflationary or above inflationary price increases. The customers of these businesses can therefore absorb inflationary prices and in certain instances, where these businesses are so special, it could be above average price increases.
Other businesses have so much scale that inflationary pressures get reduced by their buying power (ability to negotiate due to size). A company like Shoprite is able to use its buying power to keep the price of its basket of goods below that of its competition while being able to increase its revenue.
Sometimes businesses have economies of scale where the costs of producing those goods and services decrease as volumes increase. It is also possible to have almost no cost in producing additional items. Take for example a company such as Microsoft. A product like Excel is developed once and thereafter it is sold to many businesses without any real additional costs, except for maintenance and incremental development, which becomes very small as volumes increase over time.
From the above, it should be clear that the ideal company is able to increase revenue and reduce cost over time, and specifically in times when the consumer is under economic pressure. Such companies have what we call a sustainable competitive advantage. In other words, the barriers to entry are high for competition, while their products and services remain desirable.
It would therefore make sense to park your hard-earned money in a diversified portfolio of businesses that have these characteristics to allow your wealth to grow while you focus on other things.
We intuitively recognise those types of businesses:
• hospital groups like Netcare or Mediclinic
• beer brewers such as AB Inbev
• cigarette companies like British American Tobacco
• retailers such as Shoprite
• technology giants such as Google and Microsoft, etc.
Does this mean that we should just rush out to buy them? If you are a frequent flyer, you might recall a previous article where I wrote about “valuation always matters in the end”. Even great businesses cannot be bought at any price. The value of any asset is a function of today’s value of future cash generated. The excess stimulus has caused parts of financial markets to be overbought or, put differently, to be very expensive. However, the uncertainty that remains in the world causes people to act irrationally from time to time and this creates opportunities to buy into great businesses at great prices. If you don’t know when something is on sale, talk to someone who does.
René Olivier
René Olivier(CFA) is the Managing Director of Wealth Management at IJG, an established Namibian financial services market leader. IJG believes in tailoring their services to a client’s personal and business needs. For more information, visit www.ijg.net.
