Issue #13 - The durable competitive advantage and inflation
Simply put, a business with a durable competitive advantage is free to increase the prices of its products right along with inflation without experiencing a decline in demand is a good business to own. Business with the right competitive product or service as discussed in Issue #11 should be able to set their pricing to keep abreast of inflation.
Let's understand the power of being able to do this through an example.
A rental property, TP, is renting for RM4,800 per annum and the cost of maintaining the property is RM600 per annum (taking account of management fee and property rating or cukai pintu) today. After 10 years, inflation caused the cost of maintaining the property to doubled or RM1,200. If the property is good demand and the landlord is about to double the rent in pace with inflation the profit from the property also double to RM8,400 from RM4,200. Being able to increase the rent alongside with inflation allows the high profit margin to be maintained at 50%. A property that cannot earn increasing rent with inflation will face eroding profit margin. This example shows that a business with durable competitive advantage can consitently maintain its earning capacity despite inflation.
However, I am not sure if the property 'products' developed by company like SP Setia, Island & Peninsular, IGB Corporation, etc can priced to keep abreast of inflation. As far as real estate is concerned location is always one of the main factor that influence its valuation. Perhaps the company's land bank is the one aspect we could look at to evaluate its durable competitive potential.
Extending the example further, if the market values rental property at 18X its earning power the property, TP, should worth RM75,600 today and RM151,200 in year 2016. This reflects a 7.18% of compounding annual return if the property is bought in 2006 and sold in 2016 at this estimated market price. I found 2 questions that is interesting enough to be shared here.
1. What is the capital gain of selling the property in year 2016 in today's value taking into account of inflation?
-> In the above example, we assumed the rent increased at the same percentage as inflation every year. This means the inflation in the example was 7.18%. RM151,200 worth of property in year 2016 is equivalent to RM75,600 in today's value. Hence valuating the capital gain in today's money if the property is sold in year 2016 is zero.
2. What is the ROI of this investment in today's value taking into account of inflation.
-> Since it was assumed that the rent increased at the same rate as inflation every year. The rental earnings of the property each year forward is equivalent to RM4,200 (profit in year 0) in today's value. As a result, possessing the property for 10 years give a 55.56% (=10 x 4200 / 75600) ROI in today's value.
In conclusion, being able to increase price of a product or service as a result of durable competitive advantage is important to ensure the value of the business is preserved despite inflation.
Let's understand the power of being able to do this through an example.
A rental property, TP, is renting for RM4,800 per annum and the cost of maintaining the property is RM600 per annum (taking account of management fee and property rating or cukai pintu) today. After 10 years, inflation caused the cost of maintaining the property to doubled or RM1,200. If the property is good demand and the landlord is about to double the rent in pace with inflation the profit from the property also double to RM8,400 from RM4,200. Being able to increase the rent alongside with inflation allows the high profit margin to be maintained at 50%. A property that cannot earn increasing rent with inflation will face eroding profit margin. This example shows that a business with durable competitive advantage can consitently maintain its earning capacity despite inflation.
However, I am not sure if the property 'products' developed by company like SP Setia, Island & Peninsular, IGB Corporation, etc can priced to keep abreast of inflation. As far as real estate is concerned location is always one of the main factor that influence its valuation. Perhaps the company's land bank is the one aspect we could look at to evaluate its durable competitive potential.
Extending the example further, if the market values rental property at 18X its earning power the property, TP, should worth RM75,600 today and RM151,200 in year 2016. This reflects a 7.18% of compounding annual return if the property is bought in 2006 and sold in 2016 at this estimated market price. I found 2 questions that is interesting enough to be shared here.
1. What is the capital gain of selling the property in year 2016 in today's value taking into account of inflation?
-> In the above example, we assumed the rent increased at the same percentage as inflation every year. This means the inflation in the example was 7.18%. RM151,200 worth of property in year 2016 is equivalent to RM75,600 in today's value. Hence valuating the capital gain in today's money if the property is sold in year 2016 is zero.
2. What is the ROI of this investment in today's value taking into account of inflation.
-> Since it was assumed that the rent increased at the same rate as inflation every year. The rental earnings of the property each year forward is equivalent to RM4,200 (profit in year 0) in today's value. As a result, possessing the property for 10 years give a 55.56% (=10 x 4200 / 75600) ROI in today's value.
In conclusion, being able to increase price of a product or service as a result of durable competitive advantage is important to ensure the value of the business is preserved despite inflation.
posted by yitping at 11:20 PM
0 Comments:
Post a Comment
<< Home