2015: Are elevated stock prices and corporate profits relative to GNP concerning?
CAROL LOOMIS: This question comes from Mona Dyan (PH). And it concerns two indicators, Warren, that you have discussed in the past about the general level of the stock market.
The first one is the percentage of total market cap relative to the U.S. GNP, which you have said is probably the best single measure of where valuations stand at any given moment.
This indicator is at about 125 percent. That is the ratio of total market cap to U.S. GNP, and that’s about what it was when Warren talked about this back in 1999 just before the — shortly before — the bubble broke.
The second indicator, which you mentioned in a famous 1999 speech that subsequently became an article in Fortune, is the corporate profits — is corporate profits — as percent of GNP.
You had said at the time that that number ranged between 4 percent to 6 1/2 percent over a long period of time, which I believe was 1951 to 1999.
Well, as of Friday, it is about 10 1/2 percent, according to the St. Louis Federal Reserve site. That is way above the range you had mentioned.
Are the current levels of either one, or both, of these indicators a matter of concern for the general investing public?
WARREN BUFFETT: Yeah. Well, the — it might be — the second figure, which is the profits as a percentage of GDP, might be a concern for other segments of society because what it indicates is that American business has done wonderfully well in recent years.
And I know it says how — what a terrible disadvantage it has, because of U.S. tax rates and a host of other things, you know, the facts are that American business has prospered incredibly.
And the first comparison is very much affected by the fact that we live in an interest rate environment, which Charlie and I probably would have thought was almost impossible, not too many years ago.
And, obviously, profits are worth a whole lot more if the government bond yield is 1 percent, than they’re worth if the government bond yield is 5 percent.
So it gets back — and, you know, Charlie in that movie talked about alternatives and opportunity cost. And for many people, the opportunity cost is owning a lot of bonds, which pay practically nothing, or owning stocks, which are selling at fairly high prices historically, but they weren’t selling at those historic prices with interest rates like this.
So I would not — I look at those numbers, but I also look at them in the context of the fact that we’re living in a world that has incredibly low interest rates, and the question is how long those are going to prevail. Is it going to be something like Japan that goes on decade after decade, or will we be back to what we thought was normal interest rates?
If we get back to what are normal interest rates, stocks at these prices will look pretty high. If we continue with these kinds of interest rates, stocks will look very cheap. And now I’ve given you the answer and you can take your pick. (Laughs)
CHARLIE MUNGER: Well, since we failed to predict what happened, and what exists now, why would anybody ask us what our prediction is in the future? (Laughter)
WARREN BUFFETT: Yeah, yeah. We — incidentally, the one thing I can assure you, Charlie and I, to my knowledge, or my memory, I can’t recall ever us making an acquisition or turning down one based on macro factors that — you know, and we talk about deals when they come along, but whether it was See’s Candy, or whatever it might have been, the Burlington Northern we bought at a terrible time, in general economic conditions.
But we don’t — it just doesn’t come up, because we don’t — we know we don’t know what the next 12 months, 24 months, 30 — we know we don’t know what that’s going to look like. But it doesn’t really make any difference if we’re buying a business to hold for a hundred years.
What we have to do is figure out what’s likely to be the average profitability of the business over time and how strong its competitive mode is and that sort of thing.
So, people have trouble believing that. They think we talk about it. We think any company that has an economist, you know, certainly, has one employee too many. (Laughter)
Charlie? Can you think of anything rude to say that I haven’t said? (Laughter)
CHARLIE MUNGER: Well, it would be hard to top that one. (Laughter)
WARREN BUFFETT: I know. OK. (Laughter)