Don't Kid Yourself: Inflation Will Kill Stocks

The prospect of rampant money printing is often cited — even by the doom and gloomers — as a reason to be bullish on US equities in the near term, even if in the long term its a path to ruin.

Not everyone agrees. At the recent Value Investing Conference, David Einhorn warned of what inflation could do to multiples.

Bear in mind, to some extent this discussion depends on your definition of inflation. If inflation simply means money printing, then yes, inflation helps because that money has to go somewhere. But if inflation means higher prices, as seen through a rising CPI, here’s where you get into trouble.

Rolfe Winkler:

If inflation is in the cards, why might that be bad for stocks? One reason is that investors will pay less for future earnings.

Historically, according to Howard Silverblatt of Standard & Poor’s, investors have valued stocks of the S&P 500 at about 17 times earnings. If a company stands to earn a dollar per share in a given year then investors will tend to pay $17 for a share of its stock.

But if you add inflation to the mix, future earnings lose their purchasing power, which means investors won’t pay as much for them.

Einhorn, at the Value Investing Congress on Monday, said that if we wind up with significant inflation, distant earnings will be discounted at higher rates, meaning “P/E ratios will collapse.”

Read more at Reuters >

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