As bond yields rally to multiyear highs, investors may want to remember Warren Buffett’sremarks on the importance of interest rates for valuing investments.
In a 2017 interview video clip found using CNBC’s Warren Buffett Archive, the investor explained why rates matter so much for stock investors.
“The most important item over time in valuation is obviously interest rates,” Buffett said last year. “If interest rates are destined to be at low levels. … It makes any stream of earnings from investments worth more money. The bogey is always what government bonds yield.”
The yield on the benchmark 10-year Treasury note climbed to 3.12 percent Thursday, its highest mark since 2011.
The Oracle of Omaha explained that when interest rates rise to high levels such as in the early 1980s, it makes higher equity valuation multiples much less attractive to investors.
“Any investment is worth all the cash you’re going to get out between now and judgment day discounted back. The discounting back is affected by whether you choose interests rates like those of Japan or interest rates like those we had in 1982,” he said in 2017. “When we had 15 percent short-term rates in 1982, it was silly to pay 20 times earnings for stocks.”
Many investors use U.S. government bond yields as their “risk-free” discount rate in financial models to value stock investments.
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