Corporate profits

Warren Buffett’s Prediction of Corporate Profits as a Percentage of GDP

  • In a 1999 article for Fortune, Warren Buffett said that corporate profits as a percentage of US GDP are unlikely to continue to rise.
  • He cited rising inequality, which would pose political problems.
  • Although profits continued to rise, the growth of populism was among the problems he foresaw.
  • This social and political shift could tip the pendulum in favor of working people at the expense of corporate America.

In 1999, in a now famous article for Fortune, Warren Buffett explained how stocks had reached the price of perfection and investors would inevitably be disappointed (and, for what it’s worth, stocks are even more expensive today based on Buffett’s favorite metric) . Although he was wrong about reverting profit margins at the time, he might end up being right in ways he clearly hoped he wasn’t:

In my view, it takes extreme optimism to believe that corporate profits as a percentage of GDP can, for an extended period, stay well above 6%. One thing that will keep the percentage low will be the competition, which is alive and well. Moreover, there is a point of public policy: if corporate investors, as a whole, are going to eat an ever-increasing slice of the American economic pie, another group will have to settle for a smaller slice. That would rightly raise political issues – and in my view, a major slicing out of the pie just isn’t going to happen.

We haven’t seen the mean reversion that Buffett expected because “corporate investors have actually eaten an ever-increasing slice of the American economic pie and the workforce has gone up to contented with a smaller part”.

And now we’re starting to see the political issues that he envisioned that are a direct result of that splitting the pie. Populism and nationalism are just symptoms of growing animosity among voters and it’s not hard to see where it’s coming from. Men’s real median incomes have not budged in over 40 years. During the same period, real corporate profits increased about five times.

In the past, massive income inequality inspired a significant shift in government policy toward unchecked corporate powers. It could very well happen again today. In fact, socionomist Peter Atwater once proclaimed this the “Backlash erawhere voters, employees and regulators stand up and confront abuses of power seeking retaliation. This may be how the “win-win economy” finally comes to an end and the downward trend in the labor share reverses upwards.

No company represents the “win-win economy” better than FAAMG stocks. The huge piles of cash accumulated on their balance sheets are Exhibit A in this regard. And here the political pressures are already increasing very rapidly. Russian interference in the election was only the catalyst for a broader understanding of the unprecedented powers these companies now wield. As a result, there is a growing consensus that many of these companies have outgrown their own good. And it’s a consensus that is increasingly embraced by both sides of the aisle in Washington.

These are very long-term trends and they take a long time to materialize. That said, I think it’s abundantly clear that the unprecedented income inequality in our country is already inspiring social and political change that could tip the pendulum in favor of work at the expense of corporate America. In this case, Mr. Buffett will end up being right on the profit margins, even if it didn’t go as he hoped.