Thursday, June 16, 2011

Winnebago and Inflation (WGO)

This is something I wrote about Winnebago in November 2010:

A share of stock is different than an ounce of gold or a barrel of oil. The value of a company's equity is the net present value of future cash flows. The only way that inflation can increase the net present value of these future cash flows is to either (a) lower the discount rate by which the cash flows are discounted (i.e. raise the price-to-earnings multiple) or (b) increase those future cash flows. So, does inflation have either of those effects?

Inflation definitely does not raise earnings multiples. Since 1946, inflation rates higher than 5% have always corresponded to a lower range of earnings multiples. This makes sense intuitively, because why would you invest in equities unless they had a
higher earnings yield than the rate of return you could earn owning a basket of commodities?

The other possibility is that inflation results in increased earnings. Is it likely that Winnebago will have higher earnings in an environment of higher inflation? Their business model has high fixed costs (operational leverage), and a key profit driver for them would be to increase sales.

The 2010 Winnebago Tour has a base price starting at $274,554 (does not include tax, title, delivery charges, or optional features). How enthusiastic for expensive gas guzzlers will our beleaguered middle class be when diesel fuel costs close to $5 per gallon, as it did in mid-2008? And, in fact, the share price of Winnebago was crushed during the crude oil price spike during that summer.

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