Inflation
October 25, 2021
by a searcher from INSEAD in Toronto, ON, Canada
Any thoughts on how inflation could potentially impact a search process? Was also wondering about what sectors could potentially be impacted and result in better (cheaper?) valuations with higher rates potentially acting as an offset
from The University of Chicago in Chicago, IL, USA
Simple example to get the point across.
Current Sales = 1000, and Profit=15% or 150. At 5x business value V = 750.
Now assume Inflation =10%..
In a free market, business owners will raise prices to maintain the margin. History has shown that profit margins have remain steady even though inflation has occurred over the 100+ years. Businesses still make the same margin (except non-inflation impact) b/c business owners need a certain margin to cover the risks of owning a business.
So next year Sales will be 1100, Profit = 15% or 165, and V @5x will be = 825.
If you invested 100 and borrowed 650 to buy the business, then at the end of y-1, debt will be 500 (= ###-###-#### ), and the 100 investment is now worth 325 (=###-###-#### ).
In the above example, one can change the number of years, add taxes, interest, WC, add short-term margin squeeze, etc., but the directional conclusion will not change.
Further, debt is fixed. It does not increase with inflation. So with inflation, you have more $ profit to service the fixed debt.
So, I see upcoming inflation as an opportunity if one can buy a business on the basis of pre-inflation profit.
I have made above point to policy makers where I said, "inflation will make rich richer" and "wage increases will make rich richer".
from Stanford University in Paris, France