2007: Do high corporate profits make more difficult to invest?
AUDIENCE MEMBER: My name Takashi Ito (PH) from Japan.
In addition to the global excess liquidity, corporate profits are very high compared to the share of labor. Does that make it extra challenging for you to find investment opportunities? Thank you.
WARREN BUFFETT: Yes, corporate profits in the United States are — except for just a very few years — are record, in terms of GDP.
I’ve been amazed that after being in a range between 4 and 6 percent of GDP, they have jumped upward. And — (coughs) — you would not think this would be sustainable over time.
Excuse me just one second. Charlie, want to talk for a second? (Laughter)
You’ve just heard him on the subject.
But corporate profits, when they get up to 8 percent plus of GDP, you know, that is very high. And so far it has caused no reaction.
One reaction could be higher corporate taxes. You have lots and lots of businesses in this country earning 20 or 25 percent on tangible equity in a world where long-term bond rates are 4 3/4 percent — government bond rates.
That’s extraordinary. If you’d read an economics book 40 years ago and it talked about that kind of a situation persisting, you wouldn’t have found a book like that.
I mean, that does not make sense under pure economic theory, but it’s been occurring for some period of time and, as a matter of fact, it’s gotten more extreme.
Corporate profits continue to rise as a percentage of GDP. That means somebody else’s share of GDP is going down.
And you’re quite correct that the labor component of GDP has actually fallen fairly significantly.
Whether that becomes a political issue — maybe in the next campaign — whether it becomes something that Congress does something about — Congress has the power to change that ratio very quickly.
Corporate tax rates not that long ago were 52 percent and now they’re 35 percent and a whole lot of companies get by with paying 20 percent or less.
So I would say that, at the moment, corporate America is kind of living in the best of all worlds, and history has shown that those conditions don’t persist indefinitely.
What brings it to an end, when it happens, I don’t know. But I would not expect corporate profits to be eight-and-a-fraction percent of GDP, on average, in the future.
CHARLIE MUNGER: Yeah. Of course, a lot of the profits are not in the manufacturing sector or the retailing sector, either. A lot of them are in this financial sector.
And so we’ve had a huge flow of profit to banks and investment banks and investment management groups of all kinds, including various kinds of private equity.
And that has, I think, no precedent. I don’t think it’s ever been as extreme as it is now. Do you agree with that?
WARREN BUFFETT: Yeah. And Charlie and I would have said 20 years ago — and we’ve done things in banking from time to time, including owning a bank.
But if you had said to us, in a world of 4 3/4 percent long-term governments, will one major bank after another be earning more than 20 percent on tangible equity, dealing in what is basically a commodity — money — we would have said that that condition just wouldn’t persist.
Now, part of that is because the banks are geared up more. So if you earn 1 1/2 percent on deposits, you know, and you have — or 1 1/2 percent on assets — and you have assets of 15 times equity, you’re going to be earning 22 1/2 percent on equity. And by gearing up more, it does improve the return on equity.
But you still would think that would be self-neutralizing. You’d think that after one guy did it, another guy would do it, and then instead of earning 1 1/2 percent on assets, you’d earn, you know, 9/10 of a percent or 1 percent on assets, but it hasn’t happened. It’s gone on for a long time.
And, you know, we are living — I’d have to look at a chart on it, but there may have been a year or two post-World War II, but I don’t think that — I would bet there haven’t been more than two or three years in the last 75 when corporate profits, as a percentage of GDP, have been this high.
CHARLIE MUNGER: Some of this has come from consumer credit, which I think has been pushed to extremes that we’ve never before seen in the history of this country.
Some other countries that pushed consumer credit very hard had enormous collapses. Korea had one, for instance, that caused chaos for, what, two or three years? Maybe longer. So I don’t think this is a time to just swing for the fences.
WARREN BUFFETT: And the chaos in 1997 and 1998 when the IMF stepped in, I mean, it was bad in Korea for a while.
It produced some of the most ridiculously low stock prices that I’ve ever seen in my life.
In fact, I mean, you could go back to 1932 in this country and you wouldn’t have seen things any cheaper. And in the meantime, the companies rebuilt their balance sheets and their earning power.
So things do turn around in financial markets. You will — if you’re young enough, you will see everything and then some.
I mention in the annual report, in looking for an investment manager to succeed me, that we care enormously about finding somebody who’s not cognizant of everything risky that’s already happened, but that also can envision things that have not yet been experienced.
That’s our job in the insurance business, and it’s our job in the investment business.
And there are a lot of people that just don’t seem to — they’re not — they’re very smart, but they just — they’re just not wired to think about troubles that they haven’t actually witnessed before.
But, you know, that’s the problem Noah had. You know, the first 40 days, it was tough sledding for Noah, but he got revenge eventually.