Berkshire Hathaway 2018 Annual Meeting Audience Question # 46

Is there a permanent shift in the profitability of companies in the United States as a percentage of GDP?

Warren Buffett:


Carol Loomis:

In your 1999 article in Fortune magazine, you stated your belief that after-tax corporate profits were unlikely to hold much above 6 percent for any sustained period, due not only to competition but also to public policy.

You stated in the article, “If corporate investors, in aggregate, are going to eat an ever-growing portion of the economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems.”

Since 2008, after-tax corporate profits have been 8 to 10 percent of GDP. Do you believe that is a permanent shift in the U.S. economy? And of course, we have to think about the latest tax bill. Or will corporate profits revert back to the 4 percent to 6 percent of GDP range that was normal in the 20th century?

Warren Buffett:

Well, it’s been an interesting development during that period. It goes back a little bit before that period. But you now have the four largest companies, by market value, in the United States… a $30 trillion market… you have four companies that essentially don’t need any net tangible assets.

And if you go back many years, I mean, if you looked to the largest companies… Carol used to put out the Fortune 500 list. And you know, it would be AT&T and General Motors, and it was companies that… Exxon Mobil… it was companies that just required lots of capital in order to produce earnings.

So American industry has gotten incredibly more profitable, in aggregate, in the last 20 or 30 years. You look at the return on the S&P 500, the earnings as a percent of net tangible assets, and the rest is just, you know, if you buy a company that has a million dollars’ worth of net worth and you pay a billion for it, it still only had the million dollars’ of net worth. I mean you just paid more for it. So the basic profitability of the company is huge, even though your investment may be at a significantly higher price.

So that what has happened is that, I think if you look at the earnings on tangible net worth of the S&P 500 and compare it to 20 years ago, it is amazing. And that is really due to the fact that this has become somewhat, you could call it an asset-light economy.

And you know, those four companies that earn 10 percent of the… they comprise close to 10 percent of the market value of the entire publicly-traded corporate America, they don’t… and they don’t take any money, basically. And that is a changing world. And they will earn even more money with the tax rate going down.

And I don’t think people have quite processed all that information in terms of what has gone on in the market.

You don’t… you know, Carnegie built a steel mill, and then he paid it off. Or he borrowed a little money, and then he built another steel mill, and all of that sort of thing. But it was enormously capital-intensive.

And one industry after another. AT&T was enormously capital-intensive. And now the money is in the asset-light… I mean, huge money is in the… not only asset-light business… but the negative asset.

You know, IBM even, you know, had… it has no tangible… it has a net… minus tangible net worth. There’s nothing wrong with that. It’s terrific. But it is not the world we lived in 30 years ago.

And in that sense, I didn’t see that coming in 1999 when I wrote whatever I wrote there. It hasn’t changed the profitability of the asset-heavy companies particularly. I mean, it isn’t like oil.

If you take the five most capital-intensive industries in the ’90s, I don’t think you’ll find that their earnings on tangible asset have increased a lot. But you will find that this group has moved in that really doesn’t… they don’t need any net tangible assets at all, or they need very minor amounts.


Charlie Munger:

There’s also a lot of financial engineering that’s raised leverage, even in the capital-intense businesses. And you know, while Warren may have predicted a little wrong when he wrote that very scholarly article, he didn’t invest wrong. And so it just shows that it’s hard to make these economic predictions.

Warren Buffett:

OK, Jon…

Charlie Munger:

We weren’t very right on that one, Warren.

Warren Buffett:

Yeah, actually, the performance of the stock market since then has been pretty accurate.

Charlie Munger:

Yes. That’s true.

Warren Buffett:

Yeah. Being right for the wrong reason or something. Or wrong for the right reasons.

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