Hi again Jim,

> "the market price should be a function of the prospects of the underlying business"

Yes, I agree with that.

> "Arguably the most important thing in investing that few people know is that changes in prevailing interest rates do not change the value of stocks, merely their prices."

Unfortunately, I disagree with this sentence - because of the context of your surrounding post, i.e. preceded by discussion of individual companies and examples of individual companies, and followed by talk of individual stocks/sectors.

And because of the phrase 'their prices'.

The issue comes from the ambiguity in the word 'stocks'. It can mean 'stocks collectively' or 'stocks individually'.

In the context of the post, discussing individual stocks, saying 'their prices', it seems like you are talking about 'stocks individually'.

But I am guessing you may have intended to describe 'stocks collectively' for this sentence.

Stocks *viewed as a massive group* have yielded surprisingly similar returns in book growth across the course of a decade, (11-12%, per Buffett 1977), in a wide range of interest rate environments, which suggests at the *index level*, varying rates in the short or medium term do not induce *persistent* changes to *long term* value across a whole index / asset class. I imagine you know that paper already, and probably read it long before I did.

But it is not true of stocks (individually), it is not true of how they are priced or valued in a given day or year, and it is not true of the most indebted stocks, or of individual sectors of stocks.

Consider Primary Health Properties (PHP), one of the most famous UK property companies. Here are their most recent results, a week ago:

phpgroup.co.uk - Preliminary results statement vf

Their net rental income is £230 million, and profit before debt costs is £212m.

Their average cost of debt is 3.7%, giving net financing costs of £81m.

That leaves adjusted earnings of £131m.

Now, let's imagine an alternative timeline. There is a global international world war, leading to high inflation. UK gilt rates rise to 8% average. (In the past, they've been as high as 13-14% for half a decade at a time).

Since REITs borrow for 5 years at a time typically, this means effects take 5 years to feed through for a REIT, even if rates instantly dropped to zero later.

In this timeline, the cost of borrowing for a REIT has risen and stabilised at 9%.

Net financing costs change from £81m (3.7%) to £197m.

Adjusted earnings after financing costs change from £131m (£212-81) to £15m.

A drop in earnings by almost a factor of ten, persisting for most of a decade, greatly changes the book value of a stock, and utility of the earnings/dividend to investors, in my view at least.

And here, the example applies across a whole sector of similarly structured companies.

And if rates were higher? While the index is eternal, the ongoing *existence* of businesses (individually, and in groups) can be endangered by 'debt covenants', agreements with lenders that can lead to the company being forced to restructure, shrink or even shut down as soon as debt servicing costs start to look too difficult. When valuable business assets are sold off cheap in desperation, book value does not come back when rates normalise later.

This is doubly true for REITs, where public stocks compete with private equity. If PE buys up REIT assets during a catastrophe, if the value of those assets returns later, it benefits PE, not the book value of the public stocks.

And if a stock goes out of business due to debt covenants being breached by the effects of interest rates, the long term value and price are permanently gone.

So when you say,

> "Arguably the most important thing in investing that few people know is that changes in prevailing interest rates do not change the value of stocks, merely their prices."

If you add 'collectively as an asset class' or 'in aggregate in an index' after the word 'stocks', I would agree with the idea, but I also think adding something like that would change the meaning of the sentence significantly, given all the preceding and following sentences in the post talking about stocks as individual businesses, and given the mention of 'their prices'.

Sorry if this seems like nit-picking!

But it wouldn't be good for anyone to begin to think individual stocks or groups of stocks are bullet-proof over the long term, regardless of changes in interest rates.

TRS