• Choose a category
• All
• Classic-Fiction

By Root 2697 0

in spite of the inflation of the period. (To some degree the decline was due to the charging of more liberal depreciation rates. See Table 2-2.) Our extended studies have led to the conclusion that the investor cannot count on much above the recent five-year rate earned on the DJIA group—about 10% on net tangible assets (book value) behind the shares.2Since the market value of these issues is well above their book value—say, 900 market vs. 560 book in mid-1971—the earnings on current market price work out only at some 6¼%. (This relationship is generally expressed in the reverse, or “times earnings,” manner—e.g., that the DJIA price of 900 equals 18 times the actual earnings for the 12 months ended June 1971.)

Our figures gear in directly with the suggestion in the previous chapter* that the investor may assume an average dividend return of about 3.5% on the market value of his stocks, plus an appreciation of, say, 4% annually resulting from reinvested profits. (Note that each dollar added to book value is here assumed to increase the market price by about $1.60.)

The reader will object that in the end our calculations make no allowance for an increase in common-stock earnings and values to result from our projected 3% annual inflation. Our justification is the absence of any sign that the inflation of a comparable amount in the past has had any direct effect on reported per-share earnings. The cold figures demonstrate that all the large gain in the earnings of the DJIA unit in the past 20 years was due to a proportionately large growth of invested capital coming from reinvested profits. If inflation had operated as a separate favorable factor, its effect would have been to increase the “value” of previously existing capital; this in turn should increase the rate of earnings on such old capital and therefore on the old and new capital combined. But nothing of the kind actually happened in the past 20 years, during which the wholesale price level has advanced nearly 40%. (Business earnings should be influenced more by wholesale prices than by “consumer prices.”) The only way that inflation can add to common stock values is by raising the rate of earnings on capital investment. On the basis of the past record this has not been the case.

In the economic cycles of the past, good business was accompanied by a rising price level and poor business by falling prices. It was generally felt that “a little inflation” was helpful to business profits. This view is not contradicted by the history of 1950–1970, which reveals a combination of generally continued prosperity and generally rising prices. But the figures indicate that the effect of all this on the earning power of common-stock capital (“equity capital”) has been quite limited; in fact it has not even served to maintain the rate of earnings on the investment. Clearly there have been important offsetting influences which have prevented any increase in the real profitability of American corporations as a whole. Perhaps the most important of these have been (1) a rise in wage rates exceeding the gains in productivity, and (2) the need for huge amounts of new capital, thus holding down the ratio of sales to capital employed.

Our figures in Table 2-2 indicate that so far from inflation having benefited our corporations and their shareholders, its effect has been quite the opposite. The most striking figures in our table are those for the growth of corporate debt between 1950 and 1969. It is surprising how little attention has been paid by economists and by Wall Street to this development. The debt of corporations has expanded nearly fivefold while their profits before taxes a little more than doubled. With the great rise in interest rates during this period, it is evident that the aggregate corporate debt is now an adverse economic factor of some magnitude and a real problem for many individual enterprises. (Note that in 1950 net earnings after interest but before income tax were about 30% of corporate debt, while in 1969 they were only 13.2% of debt. The 1970 ratio must have