In the May 1977 issue of Fortune, Buffett published an article entitled “How Inflation Swindles the Equity Investor.” The true focus of the article is on how a corporation operates internally and how those internal processes interact with external factors in the economy and financial markets. The article focuses on how external forces—such as inflation—affect corporate behavior and how decisions made by corporations in response to these forces may harm equity investors.
Internal Compounding Drives Stock Prices
In the 1977 paper, Buffett claimed that the main issue with the stock market was that the return on capital had not increased with inflation and appeared to be stuck at 12 percent. When Buffett wrote his article, inflation and interest rates had climbed dramatically to 10% and were headed for 15% five years later. Contrary to popular expectation, corporate earnings did not rise to offset inflation. Buffet described stocks as “equity coupons,” which, unlike...