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2020: How will inflation affect capital-intensive businesses?
BECKY QUICK: All right, this question comes from Adam Schwartz in Miami, Florida. And he says Berkshire is the largest holding in his partnership, which also houses most of their net worth.
He says, “Berkshire’s invested in many capital-intensive businesses through the years, railroads as an example. How do you think about the inflationary, or even deflationary, risks for all of the capital-intensive businesses? And could this prove to be an existential problem for businesses?”
“I’m kind of referencing what you were just talking about, that eventually the bill for the debts being issued comes due. Will it eventually come from all businesses through some combination of higher tax rates on corporations, increased wages for the lower-middle classes?”
WARREN BUFFETT: Well, I certainly think that increased corporate taxes are a much higher probability than having lower corporate taxes.
So, I — I think that we got handed, as a corporation, a big chunk of what used to be the government’s profits from our business a couple of years ago. And it would depend on, to some extent, which party is elected and — and whether they have control of both houses as well as the presidency, and who knows what else.
But we could very easily have higher corporate income taxes, and perhaps much higher corporate income taxes, at some point. And in terms of capital-intensive businesses, they’re just not as good, if you can find an equally good business — I mean, in terms of operations — that doesn’t require capital.
I mean — they’re — you know, the — See’s never — See’s (Candies) never really required. It didn’t grow, but it’s — it just doesn’t — it didn’t take money to expand it and it’s delivered enormous sums to us.
And because we own it within Berkshire, to redeploy it elsewhere didn’t require a lot of tax expense either at the corporate level or at the personal level.
So, you really want a business — and everybody wants a business — that doesn’t take any capital to speak off — and keeps growing — that doesn’t take more capital as it grows.
Now, our utility business (inaudible) the energy business requires more capital as it grows. Our railroad business, to some extent, requires more capital if it doesn’t grow, even.
So capital-intensive businesses, by their nature, you know, are not as good as something where people pay in advance and you don’t need the capital.
I mean, if you look at — if you look at where the top market value is in a $30 trillion market, you know — if you take the top four or five companies that account for, you know, maybe 3 — 4 trillion or so of that 30 trillion, basically, they don’t take much capital.
And that’s why they’re worth a lot of money, because they make a lot of money and they don’t require the money, to any great extent, in the business. We own some businesses like that.
But it’s certainly not the railroad. And it’s not — it’s not the energy business. They’re good businesses. We love them. But if they didn’t take any capital, they’d be unbelievable.
But that’s just — that’s what we’ve learned from 50 or 60 years of operating businesses, that if you can find a great business that doesn’t require capital when it grows, you’ve really got something.
And to a certain extent, because insurance uses the kind of assets we would like to own anyway, our insurance business doesn’t really take capital. It requires having capital available. But, we’re able to invest that money, largely, in things we’d like to own anyway.
So, we’re particularly well suited for the insurance business. And it’s really been the most important factor in our growth over the years, although a lot of other things contribute.
Greg, you’re in a capital — you were in a capital-intensive business. (Laughs)
Tell us about it. (Laughter)
GREG ABEL: Well, I think there’s no question, obviously, we’d prefer to be in a less capital-intensive business, but there are unique opportunities there.
The one I would touch on when I think of inflation — or even potentially, as we go through this crisis, and maybe a prolonged one — or depending on how long it takes to recover — I mean, we are in a unique — when we’re looking at energy or rail — we do have a certain amount of pricing power. And it’s through our regulatory formulas or how our arrangements are with our customers.
So, if we then were to move into a deflationary period, it’s not perfect protection, but those businesses, generally, can recover a significant portion of their costs, even in an inflationary environment, and still earn a reasonable return.
They’re not going to be great returns, as you highlight, Warren. But they’re still going to earn a —
WARREN BUFFETT: Oh yeah.
GREG ABEL: — reasonable return on their capital, even in an inflationary period. There may be some lag and some things like that, but they’re still going to be very sound investments.
WARREN BUFFETT: Oh, yeah. If there was 10- for-1 inflation — make it extreme — yeah, we’d be happy we own the railroad — very happy.
Well, we’d be investing a lot of capital in it, but that businesses, in my view, is a very, very solid business for many, many, many, many decades to come. I said originally, we bought it with a hundred-year time horizon, and I’ve extended that, so —
It will earn more dollars if there’s a lot of inflation. In real terms, who knows? But it would earn a lot more dollars. And a lot of the energy projects would in the —
But it’s better if we don’t have inflation. And it’s better if we don’t have capital — (laughs) — if we can find the same sort of businesses that aren’t as capital intensive.
We — we’ve got capital. I mean, we — we’re ideally positioned for capital-intensive businesses that other people have trouble raising capital for, but they’ve still got to promise decent returns.