Collection: Warren Buffett - #12 | How Interest Rates Affect Valuation?
Hello, I’m Christopher Davis from New York City.
I’m interested in that many of the holdings of Berkshire are in industries that are perceived as interest rate-sensitive industries, including Wells Fargo, Salomon, Freddie Mac, even GEICO. And yet you have an admitted sort of ambivalence towards interest rates or changes in interest rates.
And it therefore seems that you don’t feel that those changes affect the fundamental attractiveness of those businesses.
I thought maybe you could share your thoughts on what you see in these businesses that the investment community as a whole is ignoring.
Well, the value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100 percent sensitive to interest rates, because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in, over a period of time. And the higher interest rates are, the less that present value is going to be.
So every business, by its nature, whether it’s Coca-Cola or Gillette or Wells Fargo, is in its intrinsic valuation, is a hundred percent sensitive to interest rates.
Now, the question as to whether a Wells Fargo or a Freddie Mac or whatever it may be, whether their business gets better or worse internally, as opposed to the valuation process, because of higher interest rates, that is not easy to figure.
I mean, GEICO, if they write their insurance business at the same underwriting ratio — in other words they have the same loss and expense experience relative to premiums — they benefit by higher interest rates, obviously, over time, because they’re a float business, and the float is worth more to them.
Now, externally, getting back to the valuation part, the present value of those earnings also becomes less then.
But the present value of Coke’s earnings becomes less in a higher interest rate environment.
Wells Fargo, it’s — whether they earn more or less money under any given interest rate scenario is hard to figure. There may be one short-term effect and there may be another long-term effect.
So I do not have to have a view on interest rates — and I don’t have a view on interest rates — to make a decision as to an insurance business, or a mortgage guarantor business, or a banking business, or something of the sort, relative to making a judgment about Coke or Gillette.
I’ve got nothing to add.
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"Value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100 percent sensitive to interest rates, because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in, over a period of time. And the higher interest rates are, the less that present value is going to be." ~Warren Buffett