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Berkshire Hathaway paid roughly $25 million in 1972 for See's, which equates to an after-tax rate of return of 8% ($2 million $25 million = 8%). Compare this to
government bonds in 1972, which were paying a pretax rate of return of 5.8%, and See's after-corporate-income-tax annual rate of return of 8% doesn't look too bad.
Now let's say that a steel manufacturer with poorer economics than See's produced $2 million in net earnings, on $18 million in net tangible assets. (Blast furnaces for making
steel cost considerably more than cooking pots for making candy.)
Two different businesses, both with net earnings of $2 million. The only difference is that See's produces its $2 million on a net tangible asset base of $8 million and the steel
manufacturer produces its $2 million on a net tangible asset base of $18 million.
Now let's add in inflation. Over the next ten years, prices double, as do sales and earnings. Thus both our businesses experience a doubling of earnings, to $4 million. It's easy
to figure out because all you have to do is sell the same number of units at the new inflated price, which everybody pays for with their new inflated salary.
But there is just one problem. Things wear out and eventually need to be replaced. When these two companies go to replace their net tangible asset bases, the one that had a
base of $8 million, See's, is going to have to come up with $16 million. Prices doubled not only for candy but for plants and equipment. But the steel manufacturer with a net
tangible asset base of $18 million is going to have to come up with $36 million.
Which company would you rather own See's, which has to come up with $16 million, or the steel manufacturer, which has to come up with $36 million to stay in business?
Get the point? The steel business manufacturer is going to require $20 million more of investment to produce the amount of earnings equivalent to See's.
Think of the advantages a business has if it almost never has to replace its plant and equipment and has the capacity to produce high rates of return on a small net tangible
asset base as See's does. The stock market sees this economic trick that inflation plays and responds by giving businesses like See's a higher price-to-earnings valuation
than it gives the steel business, which requires a higher net-tangible-asset base.
Inflation, though harmful to a great many businesses, can actually benefit the shareholders of companies that have a consumer monopoly working in their favor.

24
A Few Words on Taxation
You know what taxes are. But then again, I really don't know the extent of your knowledge. So since this is a book for everyone interested in investing, I need to devote a
page or two to discussing the effects of taxation on the investment process, something Warren thinks a great deal about. But don't worry, I'll keep it brief.
To the majority of investors taxes come as an afterthought. To Warren they play a very important role in the course of investment selection and the holding period.
When a corporation makes a profit for the year, it pays corporate income taxes. A company's net-income figure is an after-tax figure. The per share earnings figure is also an
after-tax figure. So when we say that Company X has earnings of $10 a share, we are saying that it has made $10 a share after paying its corporate income taxes.
Once a company has paid its corporate taxes, it can do one of three things with its net earnings. It can pay them out as dividends, retain them and add them to its existing
assets, or both.
Let's say the company we are looking at is earning $10 a share. So it can pay out all the earnings as a dividend, or retain all the earnings, or do a combination of both, paying
out, say, $7 a share in dividends and retaining $3 a share.
(Companies need not always be profitable to pay out dividends. They can reach into their asset base and pay dividends from there. This, of course, lowers the net worth of the
business.)
If the company pays out a dividend to the shareholders, the shareholders have to declare it as income and pay personal income taxes on it. If you own one share of Company
X and it pays you a dividend of $10 a share, you will have to pay income taxes on that $10. If you are in a 31% tax bracket, you will have to pay $3.10 a share in taxes, thus
reducing your take to $6.90 a share.
But if the company chooses to retain $10 a share in earnings, adding it to the company's asset base, then the shareholder is not taxed on the $10.
So if Company X retains its earnings, the effect of personal taxation is avoided.
When an investor, either a person or another corporation, sells the stock, the investor is subject to a capital gains tax on the profits. As of this writing, an individual must pay a
maximum of 20%. A corporation is taxed at normal corporate income tax rates of up to 35%. Both the percentage of tax and the holding period change periodically, reflecting
the whims of politicians and the government.
Interest payments made by a company to holders of its bonds are taxed to the recipient at personal or corporate income tax rates. Federal personal income taxes can run as
high as 39.6%. The combined state and federal income taxes for individuals can run even higher. For corporations the federal income taxes run as high as 35%.
Dividend payments from one company to another are taxed at a combined federal and state tax rate of approximately 14%. For an individual they are taxed as regular income.
This means that corporations have an advantage over individuals, who are stuck paying federal and state personal income taxes on dividend income they receive.
One could write volumes on the subject of taxation, but they would have to be rewritten every few years because the rates continually change. Be aware that taxes will always
be there to take the government's cut of your investment profits. Accordingly, we address their impact on the investment process throughout this book.

25
The Effects of Inflation and Taxation on the Rate of Return, and the Necessity to Obtain a 15 % Return on Your Investment
Warren has often stated that real-world inflation and taxation greatly alter the investor's return. He argues that if we live in a world of 5% inflation, our assets decrease in real
purchasing power by 5% every year.
For this very reason we invest our money. If we didn't, our wealth, held in cash, soon would lose its purchasing power.
If the value of our money depreciates at a rate of 5%, we have to have a return of at least 5% to offset inflation. But a return of 5% in a world of 5% inflation gives us a real

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