A Minimum Tax for the Wealthy

Mr. Warren Buffett made a strong argument in this New York Times article for a minimum tax rate for ultra rich people so some of them will not pay 0% or less than 15% tax rate again. See the article here.
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Why did he say something below? You may want to check the article yourself.

So let’s forget about the rich and ultrarich going on strike and stuffing their ample funds under their mattresses if — gasp — capital gains rates and ordinary income rates are increased. The ultrarich, including me, will forever pursue investment opportunities.      

In 1992, the tax paid by the 400 highest incomes in the United States (a different universe from the Forbes list) averaged 26.4 percent of adjusted gross income. In 2009, the most recent year reported, the rate was 19.9 percent. The group’s average income in 2009 was $202 million — which works out to a “wage” of $97,000 per hour, based on a 40-hour workweek. (I’m assuming they’re paid during lunch hours.) Yet more than a quarter of these ultrawealthy paid less than 15 percent of their take in combined federal income and payroll taxes. Half of this crew paid less than 20 percent. And — brace yourself — a few actually paid nothing.

Turnaround Story

Mickey Drexler was credited to turn GAP around during the 1990s. Check out his story - Mickey Drexler’s Redemption here.

However, Warren Buffett said " Turnarounds seldom turn. "

Can Ron Johnson in JC Penny do the same thing?

A star fund's mystery man

The manager of the country's top-performing mutual fund is a reclusive former biochemist. What's his secret?

Well, not surprisingly, he is another guy following Graham, Buffett and Fisher, a bottom-up investors. What surprisingly is that he generated 40.5% annualized return since 2007. 

Read more on Fortune March 2012 here.

Allan Mecham: The 400% Man

SmartMoney Magazine recently profiled Allan Mecham, a 34-year old college drop-out turned value investor at Arlington Value Management, who returned a cumulative 400% return over the twelve years ending December 31, 2011 (including  the astonishing 11% in 2008 and 59% in 2009 when the market was cratering). Rather than investing in unknown microcaps that soar after being “discovered” by the mainstream financial community, much of Mecham’s returns have been earned from large caps.

Read the rest of the article here.

You can then read the follow-up article called The 400% Man's New Big Bet

[L]ast year he levered up the fund and has invested half the money in Warren Buffett’s Berkshire Hathaway. 
“Able to borrow at around 1.5%, we levered (Berkshire) into a 50%+ position,” he wrote in his annual letter to shareholders. “Though not advocates of leverage, we believe the low cost and modest amount, combined with [Berkshire's] iron-clad safety and cheap price, makes our action sensible.”
There is some method to the madness. Mecham, a long-term Buffett disciple, argues that Berkshire Hathaway stock, on its own, “provides ample diversity, with exposure to disparate businesses (more than 70), sectors, and asset allocations.” Berkshire’s assets include a ton of cash-generative businesses, a book of blue-chip public stocks valued at more than $75 billion, and nearly $40 billion in cash, he says.

He was also interviewed by The Manual of Ideas starting from p7. Check here.

Wells Fargo Reports 13% Increase in Q1 2012 Profits

While all banks are under great distress, WFC has been grabbing the mortgage lending business from others. I will buy and accumulate during its price weakness from now on to the next few years.  JC 4/17/2012
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Amid improvements in the mortgage sector, Wells Fargo & Company reported a 13 percent increase in first quarter profits, with a net income of $4.25 billion, and earnings per share at $0.75. Last year during the same quarter, the bank reported a net income of $3.76 billion, or $0.67 per share.

 Revenue increased $1 billion from fourth quarter 2011, to $21.6 billion. The $1 billion increase was driven by increases of $506 million in mortgage banking, $458 million in market sensitive revenue, and $181 million in trust and investment fees, the report stated.

Read more here.

Warren Buffett's View on Single Family Home Investment

On Monday, February 27, 2012 Warren Buffett appeared live on CNBC for his annual “Ask Warren” marathon. During this interview he mentioned that one of the best investment opportunities around right now in the United States are Single Family Homes!

BUFFETT: I would say that single-family homes are cheap now, too.

BECKY: You would?

BUFFETT: Yeah, single-family homes— but if I had a way of buying a couple hundred thousand single-family homes and had a way of managing— the management is enormous— is really the problem because they're one by one. They're not like apartment houses. So— but I would load up on them and I would take mortgages out at very, very low rates. But if anybody is thinking about buying a home— five years ago they couldn't buy them fast enough because they thought they were going to go up, and now they don't buy them because they think they're going to go down. And interest rates are far lower. It's a way, in effect, to short the dollar because you can— you can take a 30-year mortgage and if it turns out your interest rate is too high, next week you refinance lower. And if it turns out it's too low, the other guy's stuck with it for 30 years. So it's a very attractive asset class now.

BECKY: If you are a young individual investor at home and you have your choice between buying your first home or investing in stocks, where would you tell someone is the better bet?

BUFFETT: Well, if I thought I was going to live— if I knew where I was going to want to live the next five or 10 years I would— I would buy a home and I'd finance it with a 30-year mortgage, and it's a terrific deal. And if I— literally, if I was an investor that was a handy type, which I'm not, and I could buy a couple of them at distressed prices and find renters, I think that's— and again take a 30-year mortgage, it's a leveraged way of owning a very cheap asset now and I think that's probably as an attractive an investment as you can make now.

Warren Buffett: Why stocks beat gold and bonds

In an adaptation from his upcoming shareholder letter, the Oracle of Omaha explains why equities almost always beat the alternatives over time.   By Warren Buffett 

At Berkshire Hathaway (BRKA) we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power -- after taxes have been paid on nominal gains -- in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.  

Read more here. 

Ted Weschler: More on Warren Buffett’s Reluctant Sidekick

WSJ, 1/3/2012


In the span of about a year, hedge-fund manager Ted Weschler twice dined with Warren Buffett at Piccolo’s, one of the billionaire investor’s favorite Omaha, Neb., haunts.

Along the way, Mr. Weschler would step out of a crowd of Buffett disciples to become one of a few candidates to replace the Oracle of Omaha as chief investment officer at Berkshire Hathaway Inc. By the end of his second meal at Piccolo’s, Mr. Weschler would have a job offer in hand.

This post is based on interviews with people familiar with Mr. Weschler, Mr. Buffett, and Berkshire. Weschler will start work at Berkshire Hathaway this month, and the challenges of the job were detailed in a Wall Street Journal story today.

Even though Mr. Weschler considered Mr. Buffett a hero, he wasn’t about to trade in his below-the-radar life in Charlottesville, Va., for the challenge of trying to succeed Mr. Buffett. Over the past decade, his fund, Peninsula Capital, had turned in a strong double-digit-percentage annualized return, while the broad Standard & Poor’s 500-stock index was basically flat.

Considering how much money he had made for himself and investors — people familiar with Peninsula estimate that about 40% of its $2 billion in assets is Mr. Weschler’s money — he had enjoyed a fairly anonymous life.

That would begin to change in June 2010, when Mr. Weschler paid a visit to Glide, a homeless charity in San Francisco that Mr. Buffett supports. That very week, Glide was holding its annual fundraiser: an auction, with the top bidder winning a lunch date with Mr. Buffett.

Read the complete article on WSJ

Buffett not timing the market. You shouldn't Either!

In 3 Things to Remember About Buffett's Buying Spree by fool.com, Morgan said 


Buffett doesn't call bottoms. Anything could happen from here.


One of the best stories about Buffett buying stocks is his experience with The Washington Post Co.. As Andy Kilpatrick explained in his book Of Permanent Value:

After Buffett's purchase, the stock fell for the next two years, and Buffett's investment sank from $10 million in 1973 to $8 million in 1974. Post Co. stock did not move solidly ahead of Buffett's purchase price until 1976. Now the stake is worth more than $1 billion.

That's incredible when you think about it. Washington Post stock fell 20% and sat there for years after Buffett bought it, and it ended up being one of the best investments Berkshire ever made.


Buffett isn't concerned about timing bottoms ...... I don't think it would bother him one bit if stocks fell considerably from his recent buy prices. The goal is to buy good companies at good prices and hold them for as long as possible. 


Too many forget that when analyzing his moves. In October 2008, Buffett wrote an op-ed in The New York Times. "I've been buying American stocks," he wrote. "If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities."
Stocks fell another 33% after the article was published. Some poked fun. Bad timing, they said. "Warren Buffett loses his Midas touch as shares drop," read one headline in early 2009.
But was it a bad move? Three years later, the S&P 500 is up about 30% from the day his op-ed was published. Ten or 20 years from now, the buys are likely to look even more prescient. It all comes down to your time frame.


Ideally, most investors try to follow that philosophy. In reality, few do. It's hard to be against the whole market stampede. I'm on the journey to summon up my courage to do it when the street is bloody. The results are good so far. 


See my another post about what I did during Aug - Oct 2011. 

I too went on shopping spree

In the article of Berkshire spree targets industrial groups from Financial Times on November 7, 2011, it said

Berkshire Hathaway, the conglomerate run by Warren Buffett, went on an aggressive buying spree of stocks in the last quarter and shifted its portfolio’s focus from banks and consumer product companies to industrial businesses.

As markets whipsawed on volatile economic data, the US debt ceiling debate and the eurozone sovereign debt crisis, Mr Buffett and his team was unusually active in buying stocks.

I'm glad that I too bought a lot (close to 50% of the total portfolio) from Aug 8 to Oct 4 including 3M, BRK, .....  Yes. They are industrial. Can I be counted as a virtual team member of Berkshire Hathway?

During this period, I truly experienced what does it mean of " Be greedy when every one else is fearful". I recall that during the first two big dips in early August and early September, I was very happy with joyful and hopeful mood to buy quite a bunch. Towards the end of September, I bought more shares with courage that I need to summon up with good inner strength.

More to share in the near future.

Josh

Warren Buffett's Mr. Fix-It , David Sokol

FORTUNE -- The day after Lehman collapsed in September 2008, David Sokol noticed that the stock of Constellation Energy, a Baltimore utility, was plummeting. He called his boss, Warren Buffett, and said, "I see an opportunity here." Buffett, who had noticed the same thing, replied after a brief discussion: "Let's go after it."

Constellation (CEG, Fortune 500) held vast amounts of energy futures contracts that had gone sour, and the company appeared to be on the verge of bankruptcy. Sokol, as chairman of the Berkshire subsidiary MidAmerican Energy Holdings, knew the utility industry and saw a chance to buy solid assets at a bargain price. The deal, however, had to be done within 48 hours or the company would have to file for bankruptcy.

The full article can be found here

The Next Warren Buffett?

Financier Eddie Lampert turned once-bankrupt Kmart into a $3 billion cash cow. Will he build it into a new Berkshire Hathaway?


http://www.businessweek.com/magazine/content/04_47/b3909001_mz001.htm

The Business Week article.

Behind Buffett’s Decision, a Lesson From a Mentor

Behind Buffett’s Decision, a Lesson From a Mentor

Posted: 03 Nov 2009 08:20 PM PST

By Jason Zweig (WSJ)

Warren Buffett’s purchase of Burlington Northern Santa Fe Corp. (BNI) is the newest chapter in the oldest story of his professional life.

Mr. Buffett’s mentor, the pioneering “value” investor Benjamin Graham, trafficked for decades in railroad stocks and bonds. In the early 1950s, at the outset of his career, Mr. Buffett read every page in Moody’s voluminous transportation manuals — twice, to make sure he didn’t miss anything. Working at Mr. Graham’s fund, Graham-Newman Corp., Mr. Buffett analyzed a portfolio with 21% to 36% of its assets in railroads.

But there is a more subtle side to the story. Mr. Graham taught Mr. Buffett that at the heart of the relationship between management and shareholders is a profound conflict of interest. Managers, Mr. Graham believed, will always want to pile up cash to protect themselves in case they make mistakes. But that cash belongs to the shareholders, who may be able to put it to better use than the company’s managers.

Graham also highlighted a painful paradox: The better the business and the more skilled its managers, the greater its profits, causing cash to pile up to unreasonable levels. And, to Mr. Buffett’s own chronic discomfort, he and Berkshire Hathaway are living proof of Mr. Graham’s paradox. Because of Mr. Buffett’s extraordinary skill at picking stocks and buying lucrative businesses, Berkshire consistently generates far more cash than even Mr. Buffett thinks he can put to productive use.

As long ago as 1998 — when Berkshire had $122 billion in assets and less than $14 billion in cash — Mr. Buffett worried his company was getting too big for its britches. “We have always known,” he wrote to a fellow investor, “that huge increases in managed funds would dramatically diminish our universe of investment choices.” That’s because investments of a few million dollars apiece could no longer make a material difference to Berkshire’s fortunes.

By 2006, when Berkshire’s cash mountain had risen to $37 billion, Mr. Buffett said, “We don’t like excess cash…We would be much happier if we had $10 billion.”

“Size is always a problem,” Mr. Buffett told me last month. “With tiny sums [to invest], it’s extraordinary what you can find. Most of the time, big sums are one hell of an anchor.”

Mr. Buffett would rather not resort to the simplest way of solving this problem — paying excess cash out to shareholders in the form of a dividend. Since he owns roughly 26% of Berkshire’s shares, a cash dividend would saddle Mr. Buffett with one of the largest personal-income tax bills in American history. That’s not the kind of thing at which he likes to excel. Mr. Buffett’s reluctance to pay a dividend leaves him with little choice but to buy big companies outright.

Mr. Buffett is paying for Burlington Northern partly with Berkshire shares — something he has long been loath to do. In 2007 he lamented buying Dexter Shoe in 1993 for $433 million in Berkshire stock — which would later have been worth at least $3.5 billion if Mr. Buffett had not exchanged them for Dexter, which ended up worthless. “He’s so sensitive to this issue that I can’t believe he would [pay in stock for Burlington Northern] unless he had absolute confidence that it will work out well over time,” says David Carr of Oak Value Fund, which owns $25 million in Berkshire shares.

At age 79, Mr. Buffett has no plans to retire, but he wants to ensure that Berkshire’s businesses will endure for decades after he is gone. He is betting that no new technology can make rail transportation obsolete. Mr. Buffett has sometimes been wrong about which businesses will prosper forever. Over the years, he’s invested in shoes, newspapers and printed encyclopedias. But Mr. Buffett’s approach underscores a key lesson for any investor: Before you buy any business, ask how vulnerable it is to new technology or price competition.

As a result of the Burlington Northern deal, Berkshire’s Class B shares will split 50-for-1, which would knock its share price down from $3,300 to $65. That puts the shares, for the first time in years, within psychological reach of most investors (who have long balked at Berkshire’s high per-share price).

Like Burlington Northern itself, Berkshire’s shares aren’t quite a steal. Mr. Buffett is putting tens of billions of dollars into a company that he thinks has only moderate growth prospects. That implies that the market as a whole isn’t a steal, or he would have put the money elsewhere. But Mr. Buffett has built an investing bulwark — and an industrial conglomerate. Berkshire is likely to survive any storm, but whether it can continue to beat the market by such wide margins is another story.

The Greenback Effect by Warren Buffett 8-19-2009

The Greenback Effect

By WARREN E. BUFFETT

Published: August 18, 2009

http://www.nytimes.com/2009/08/19/opinion/19buffett.html?pagewanted=1&_r=2&ref=opinion&adxnnlx=1250705844-LfABFNPAbeHVZXcsKqynpg

IN nature, every action has consequences, a phenomenon called the butterfly effect. These consequences, moreover, are not necessarily proportional. For example, doubling the carbon dioxide we belch into the atmosphere may far more than double the subsequent problems for society. Realizing this, the world properly worries about greenhouse emissions.

The butterfly effect reaches into the financial world as well. Here, the United States is spewing a potentially damaging substance into our economy — greenback emissions.

To be sure, we’ve been doing this for a reason I resoundingly applaud. Last fall, our financial system stood on the brink of a collapse that threatened a depression. The crisis required our government to display wisdom, courage and decisiveness. Fortunately, the Federal Reserve and key economic officials in both the Bush and Obama administrations responded more than ably to the need.

They made mistakes, of course. How could it have been otherwise when supposedly indestructible pillars of our economic structure were tumbling all around them? A meltdown, though, was avoided, with a gusher of federal money playing an essential role in the rescue.

The United States economy is now out of the emergency room and appears to be on a slow path to recovery. But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.

To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 percent of gross domestic product. This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion. Fiscally, we are in uncharted territory.

Because of this gigantic deficit, our country’s “net debt” (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent. Admittedly, other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to G.D.P. at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out.

An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually — and in combination.

The current account deficit — dollars that we force-feed to the rest of the world and that must then be invested — will be $400 billion or so this year. Assume, in a relatively benign scenario, that all of this is directed by the recipients — China leads the list — to purchases of United States debt. Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased.

Then take the second element of the scenario — borrowing from our own citizens. Assume that Americans save $500 billion, far above what they’ve saved recently but perhaps consistent with the changing national mood. Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).

Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington’s printing presses will need to work overtime.

Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.

Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes. In fact, John Maynard Keynes long ago laid out a road map for political survival amid an economic disaster of just this sort: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.... The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

I want to emphasize that there is nothing evil or destructive in an increase in debt that is proportional to an increase in income or assets. As the resources of individuals, corporations and countries grow, each can handle more debt. The United States remains by far the most prosperous country on earth, and its debt-carrying capacity will grow in the future just as it has in the past.

But it was a wise man who said, “All I want to know is where I’m going to die so I’ll never go there.” We don’t want our country to evolve into the banana-republic economy described by Keynes.

Our immediate problem is to get our country back on its feet and flourishing — “whatever it takes” still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress.

Warren Buffett bought more on Wells Farg in Q1 09

It was reported that Buffett bought almost 12.4 million shares of Wells Fargo in the first quarter.

Berkshire invests in Wells Fargo

On Friday May 15, 2009, 6:55 pm EDT

............... So perhaps it shouldn't be surprising that Berkshire bought nearly 12.4 million shares of Wells Fargo during the first quarter, giving it 302.6 million shares of the San Francisco-based bank. ................................

See more details in the following link.

http://finance.yahoo.com/news/Berkshire-invests-in-Wells-apf-15268839.html?.v=5


It's not surprising that many people think he made mistakes this time.

Four Reasons Why Warren Buffett Could Be Wrong About Wells Fargo

Was he wrong? Time will definitely tell. Let's chat two years from now.

Wells Fargo and its take-over of Wachovia

Want to know more about Wells Fargo and its take-over of Wachovia? Check the article below.

Riders on the storm

Wells Fargo avoided the reckless tactics of other banks and quietly built a powerhouse in the West. Now its takeover of Wachovia makes it a national force, but how much toxic waste is aboard the stagecoach?

Warren Buffett on Wells Fargo 4-20-2009

Warren Buffett on Wells Fargo

'Banking is a very good business unless you do dumb things,' says Wells Fargo's largest shareholder.

Interview by Adam Lashinsky

April 20, 2009: 6:13 AM ET

http://money.cnn.com/2009/04/19/news/companies/lashinsky_buffett.fortune/index.htm?postversion=2009042006

Fixing Growing Trade Deficit by Warren Buffett

America’s Growing Trade Deficit Is Selling the Nation Out From Under Us.
Here’s a Way to Fix the Problem—And We Need to Do It Now.

by Warren E. Buffett

http://www.berkshirehathaway.com/letters/growing.pdf


On FORTUNE Magazine Nov 10, 2003

THE SUPERINVESTORS OF GRAHAM-AND-DODDSVILLE

This article is an edited transcript of a talk given at Columbia University in 1984 commemorating the fiftieth anniversary of Security Analysis, written by Benjamin Graham and David L. Dodd. This specialized volume first introduced the ideas later popularized in The Intelligent Investor. Buffett's essay offers a fascinating study of how Graham's disciples have used Graham's value investing approach to realize phenomenal success in the stock market.

Here is the version of the speech (a 1.6 MB .pdf file), which has all of the tables.

http://www.tilsonfunds.com/superinvestors.pdf

THE MARKET - Mr. Buffett on the Stock Market, FORTUNE Nov 22, 1999

THE MARKET - Mr. Buffett on the Stock Market

FORTUNE Nov 22, 1999

The most celebrated of investors says stocks can't possibly meet the public's expectations. As for the Internet? He notes how few people got rich from two other transforming industries, auto and aviation.

Warren Buffett, chairman of Berkshire Hathaway, almost never talks publicly about the general level of stock prices--neither in his famed annual report nor at Berkshire's thronged annual meetings nor in the rare speeches he gives. But in the past few months, on four occasions, Buffett did step up to that subject, laying out his opinions, in ways both analytical and creative, about the long-term future for stocks. FORTUNE's Carol Loomis heard the last of those talks, given in September to a group of Buffett's friends (of whom she is one), and also watched a videotape of the first speech, given in July at Allen & Co.'s Sun Valley, Idaho, bash for business leaders. From those extemporaneous talks (the first made with the Dow Jones industrial average at 11,194), Loomis distilled the following account of what Buffett said. Buffett reviewed it and weighed in with some clarifications.

Investors in stocks these days are expecting far too much, and I'm going to explain why. That will inevitably set me to talking about the general stock market, a subject I'm usually unwilling to discuss. But I want to make one thing clear going in: Though I will be talking about the level of the market, I will not be predicting its next moves. At Berkshire we focus almost exclusively on the valuations of individual companies, looking only to a very limited extent at the valuation of the overall market. Even then, valuing the market has nothing to do with where it's going to go next week or next month or next year, a line of thought we never get into. The fact is that markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts. So what I am going to be saying--assuming it's correct--will have implications for the long-term results to be realized by American stockholders.

Let's start by defining "investing." The definition is simple but often forgotten: Investing is laying out money now to get more money back in the future--more money in real terms, after taking inflation into account.

Now, to get some historical perspective, let's look back at the 34 years before this one--and here we are going to see an almost Biblical kind of symmetry, in the sense of lean years and fat years--to observe what happened in the stock market. Take, to begin with, the first 17 years of the period, from the end of 1964 through 1981. Here's what took place in that interval:

DOW JONES INDUSTRIAL AVERAGE

Dec. 31, 1964: 874.12

Dec. 31, 1981: 875.00

Now I'm known as a long-term investor and a patient guy, but that is not my idea of a big move.

And here's a major and very opposite fact: During that same 17 years, the GDP of the U.S.--that is, the business being done in this country--almost quintupled, rising by 370%. Or, if we look at another measure, the sales of the FORTUNE 500 (a changing mix of companies, of course) more than sextupled. And yet the Dow went exactly nowhere.

To understand why that happened, we need first to look at one of the two important variables that affect investment results: interest rates. These act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That's because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. Conversely, if government interest rates fall, the move pushes the prices of all other investments upward. The basic proposition is this: What an investor should pay today for a dollar to be received tomorrow can only be determined by first looking at the risk-free interest rate.

Consequently, every time the risk-free rate moves by one basis point--by 0.01%--the value of every investment in the country changes. People can see this easily in the case of bonds, whose value is normally affected only by interest rates. In the case of equities or real estate or farms or whatever, other very important variables are almost always at work, and that means the effect of interest rate changes is usually obscured. N onetheless, the effect--like the invisible pull of gravity--is constantly there.

In the 1964-81 period, there was a tremendous increase in the rates on long-term government bonds, which moved from just over 4% at year-end 1964 to more than 15% by late 1981. That rise in rates had a huge depressing effect on the value of all investments, but the one we noticed, of course, was the price of equities. So there--in that tripling of the gravitational pull of interest rates--lies the major explanation of why tremendous growth in the economy was accompanied by a stock market going nowhere.

Then, in the early 1980s, the situation reversed itself. You will remember Paul Volcker coming in as chairman of the Fed and remember also how unpopular he was. But the heroic things he did--his taking a two-by-four to the economy and breaking the back of inflation--caused the interest rate trend to reverse, with some rather spectacular results. Let's say you put $1 million into the 14% 30-year U.S. bond issued Nov. 16, 1981, and reinvested the coupons. That is, every time you got an interest payment, you used it to buy more of that same bond. At the end of 1998, with long-term governments by then selling at 5%, you would have had $8,181,219 and would have earned an annual return of more than 13%.

That 13% annual return is better than stocks have done in a great many 17-year periods in history--in most 17-year periods, in fact. It was a helluva result, and from none other than a stodgy bond.

The power of interest rates had the effect of pushing up equities as well, though other things that we will get to pushed additionally. And so here's what equities did in that same 17 years: If you'd invested $1 million in the Dow on Nov. 16, 1981, and reinvested all dividends, you'd have had $19,720,112 on Dec.31, 1998. And your annual return would have been 19%.

The increase in equity values since 1981 beats anything you can find in history. This increase even surpasses what you would have realized if you'd bought stocks in 1932, at their Depression bottom--on its lowest day, July 8, 1932, the Dow closed at 41.22--and held them for 17 years.

The second thing bearing on stock prices during this 17 years was after-tax corporate profits, which this chart [above] displays as a percentage of GDP. In effect, what this chart tells you is what portion of the GDP ended up every year with the shareholders of American business.

The chart starts in 1929. I'm quite fond of 1929, since that's when it all began for me. My dad was a stock salesman at the time, and after the Crash came, in the fall, he was afraid to call anyone--all those people who'd been burned. So he just stayed home in the afternoons. And there wasn't television then. Soooo...I was conceived on or about Nov. 30,1929 (and born nine months later, on Aug. 30, 1930), and I've forever had a kind of warm feeling about the Crash.

Corporate profits as a percentage of GDP peaked in 1929, and then they tanked. The left-hand side of the chart, in fact, is filled with aberrations: not only the Depression but also a wartime profits boom--sedated by the excess-profits tax--and another boom after the war. But from 1951 on, the percentage settled down pretty much to a 4% to 6.5% range.

By 1981, though, the trend was headed toward the bottom of that band, and in 1982 profits tumbled to 3.5%. So at that point investors were looking at two strong negatives: Profits were sub-par and interest rates were sky-high.

And as is so typical, investors projected out into the future what they were seeing. That's their unshakable habit: looking into the rear-view mirror instead of through the windshield. What they were observing, looking backward, made them very discouraged about the country. They were projecting high interest rates, they were projecting low profits, and they were therefore valuing the Dow at a level that was the same as 17 years earlier, even though GDP had nearly quintupled.

Now, what happened in the 17 years beginning with 1982? One thing that didn't happen was comparable growth in GDP: In this second 17-year period, GDP less than tripled. But interest rates began their descent, and after the Volcker effect wore off, profits began to climb--not steadily, but nonetheless with real power. You can see the profit trend, which shows that by the late 1990s, after-tax profits as a percent of GDP were running close to 6%, which is on the upper part of the "normalcy" band. And at the end of 1998, long-term government interest rates had made their way down to that 5%.

These dramatic changes in the two fundamentals that matter most to investors explain much, though not all, of the more than tenfold rise in equity prices--the Dow went from 875 to 9,181--during this 17-year period. What was at work also, of course, was market psychology. Once a bull market gets under way, and once you reach the point where everybody has made money no matter what system he or she followed, a crowd is attracted into the game that is responding not to interest rates and profits but simply to the fact that it seems a mistake to be out of stocks. In effect, these people superimpose an I-can't-miss-the-party factor on top of the fundamental factors that drive the market. Like Pavlov's dog, these "investors" learn that when the bell rings--in this case, the one that opens the New York Stock Exchange at 9:30 a.m.--they get fed. Through this daily reinforcement, they become convinced that there is a God and that He wants them to get rich.

Today, staring fixedly back at the road they just traveled, most investors have rosy expectations. A Paine Webber and Gallup Organization survey released in July shows that the least experienced investors--those who have invested for less than five years--expect annual returns over the next ten years of 22.6%. Even those who have invested for more than 20 years are expecting 12.9%.

Now, I'd like to argue that we can't come even remotely close to that 12.9%, and make my case by examining the key value-determining factors. Today, if an investor is to achieve juicy profits in the market over ten years or 17 or 20, one or more of three things must happen. I'll delay talking about the last of them for a bit, but here are the first two:

(1) Interest rates must fall further. If government interest rates, now at a level of about 6%, were to fall to 3%, that factor alone would come close to doubling the value of common stocks. Incidentally, if you think interest rates are going to do that--or fall to the 1% that Japan has experienced--you should head for where you can really make a bundle: bond options.

(2) Corporate profitability in relation to GDP must rise. You know, someone once told me that New York has more lawyers than people. I think that's the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there's a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems--and in my view a major reslicing of the pie just isn't going to happen.

So where do some reasonable assumptions lead us? Let's say that GDP grows at an average 5% a year--3% real growth, which is pretty darn good, plus 2% inflation. If GDP grows at 5%, and you don't have some help from interest rates, the aggregate value of equities is not going to grow a whole lot more. Yes, you can add on a bit of return from dividends. But with stocks selling where they are today, the importance of dividends to total return is way down from what it used to be. Nor can investors expect to score because companies are busy boosting their per-share earnings by buying in their stock. The offset here is that the companies are just about as busy issuing new stock, both through primary offerings and those ever present stock options.

So I come back to my postulation of 5% growth in GDP and remind you that it is a limiting factor in the returns you're going to get: You cannot expect to forever realize a 12% annual increase--much less 22%--in the valuation of American business if its profitability is growing only at 5%. The inescapable fact is that the value of an asset, whatever its character, cannot over the long term grow faster than its earnings do.

Now, maybe you'd like to argue a different case. Fair enough. But give me your assumptions. If you think the American public is going to make 12% a year in stocks, I think you have to say, for example, "Well, that's because I expect GDP to grow at 10% a year, dividends to add two percentage points to returns, and interest rates to stay at a constant level." Or you've got to rearrange these key variables in some other manner. The Tinker Bell approach--clap if you believe--just won't cut it.

Beyond that, you need to remember that future returns are always affected by current valuations and give some thought to what you're getting for your money in the stock market right now. Here are two 1998 figures for the FORTUNE 500. The companies in this universe account for about 75% of the value of all publicly owned American businesses, so when you look at the 500, you're really talking about America Inc.

FORTUNE 500

1998 profits: $334,335,000,000

Market value on March 15, 1999: $9,907,233,000,000

As we focus on those two numbers, we need to be aware that the profits figure has its quirks. Profits in 1998 included one very unusual item--a $16 billion bookkeeping gain that Ford reported from its spinoff of Associates--and profits also included, as they always do in the 500, the earnings of a few mutual companies, such as State Farm, that do not have a market value. Additionally, one major corporate expense, stock-option compensation costs, is not deducted from profits. On the other hand, the profits figure has been reduced in some cases by write-offs that probably didn't reflect economic reality and could just as well be added back in. But leaving aside these qualifications, investors were saying on March 15 this year that they would pay a hefty $10 trillion for the $334 billion in profits.

Bear in mind--this is a critical fact often ignored--that investors as a whole cannot get anything out of their businesses except what the businesses earn. Sure, you and I can sell each other stocks at higher and higher prices. Let's say the FORTUNE 500 was just one business and that the people in this room each owned a piece of it. In that case, we could sit here and sell each other pieces at ever-ascending prices. You personally might outsmart the next fellow by buying low and selling high. But no money would leave the game when that happened: You'd simply take out what he put in. Meanwhile, the experience of the group wouldn't have been affected a whit, because its fate would still be tied to profits. The absolute most that the owners of a business, in aggregate, can get out of it in the end--between now and Judgment Day--is what that business earns over time.

And there's still another major qualification to be considered. If you and I were trading pieces of our business in this room, we could escape transactional costs because there would be no brokers around to take a bite out of every trade we made. But in the real world investors have a habit of wanting to change chairs, or of at least getting advice as to whether they should, and that costs money--big money. The expenses they bear--I call them frictional costs--are for a wide range of items. There's the market maker's spread, and commissions, and sales loads, and 12b-1 fees, and management fees, and custodial fees, and wrap fees, and even subscriptions to financial publications. And don't brush these expenses off as irrelevancies. If you were evaluating a piece of investment real estate, would you not deduct management costs in figuring your return? Yes, of course--and in exactly the same way, stock market investors who are figuring their returns must face up to the frictional costs they bear.

And what do they come to? My estimate is that investors in American stocks pay out well over $100 billion a year--say, $130 billion--to move around on those chairs or to buy advice as to whether they should! Perhaps $100 billion of that relates to the FORTUNE 500. In other words, investors are dissipating almost a third of everything that the FORTUNE 500 is earning for them--that $334 billion in 1998--by handing it over to various types of chair-changing and chair-advisory "helpers." And when that handoff is completed, the investors who own the 500 are reaping less than a $250 billion return on their $10 trillion investment. In my view, that's slim pickings.

Perhaps by now you're mentally quarreling with my estimate that $100 billion flows to those "helpers." How do they charge thee? Let me count the ways. Start with transaction costs, including commissions, the market maker's take, and the spread on underwritten offerings: With double counting stripped out, there will this year be at least 350 billion shares of stock traded in the U.S., and I would estimate that the transaction cost per share for each side--that is, for both the buyer and the seller--will average 6 cents. That adds up to $42 billion.

Move on to the additional costs: hefty charges for little guys who have wrap accounts; management fees for big guys; and, looming very large, a raft of expenses for the holders of domestic equity mutual funds. These funds now have assets of about $3.5 trillion, and you have to conclude that the annual cost of these to their investors--counting management fees, salesloads, 12b-1 fees, general operating costs--runs to at least 1%, or $35 billion.

And none of the damage I've so far described counts the commissions and spreads on options and futures, or the costs borne by holders of variable annuities, or the myriad other charges that the "helpers" manage to think up. In short, $100 billion of frictional costs for the owners of the FORTUNE 500--which is 1% of the 500's market value--looks to me not only highly defensible as an estimate, but quite possibly on the low side.

It also looks like a horrendous cost. I heard once about a cartoon in which a news commentator says, "There was no trading on the New York Stock Exchange today. Everyone was happy with what they owned." Well, if that were really the case, investors would every year keep around $130 billion in their pockets.

Let me summarize what I've been saying about the stock market: I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like--anything like--they've performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate--repeat, aggregate--would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more.

Let me come back to what I said earlier: that there are three things that might allow investors to realize significant profits in the market going forward. The first was that interest rates might fall, and the second was that corporate profits as a percent of GDP might rise dramatically. I get to the third point now: Perhaps you are an optimist who believes that though investors as a whole may slog along, you yourself will be a winner. That thought might be particularly seductive in these early days of the information revolution (which I wholeheartedly believe in). Just pick the obvious winners, your broker will tell you, and ride the wave.

Well, I thought it would be instructive to go back and look at a couple of industries that transformed this country much earlier in this century: automobiles and aviation. Take automobiles first: I have here one page, out of 70 in total, of car and truck manufacturers that have operated in this country. At one time, there was a Berkshire car and an Omaha car. Naturally I noticed those. But there was also a telephone book of others.

All told, there appear to have been at least 2,000 car makes, in an industry that had an incredible impact on people's lives. If you had foreseen in the early days of cars how this industry would develop, you would have said, "Here is the road to riches." So what did we progress to by the 1990s? After corporate carnage that never let up, we came down to three U.S. car companies--themselves no lollapaloozas for investors. So here is an industry that had an enormous impact on America--and also an enormous impact, though not the anticipated one, on investors.

Sometimes, incidentally, it's much easier in these transforming events to figure out the losers. You could have grasped the importance of the auto when it came along but still found it hard to pick companies that would make you money. But there was one obvious decision you could have made back then--it's better sometimes to turn these things upside down--and that was to short horses. Frankly, I'm disappointed that the Buffett family was not short horses through this entire period. And we really had no excuse: Living in Nebraska, we would have found it super-easy to borrow horses and avoid a "short squeeze."

U.S. Horse Population

1900: 21 million

1998: 5 million

The other truly transforming business invention of the first quarter of the century, besides the car, was the airplane--another industry whose plainly brilliant future would have caused investors to salivate. So I went back to check out aircraft manufacturers and found that in the 1919-39 period, there were about 300 companies, only a handful still breathing today. Among the planes made then--we must have been the Silicon Valley of that age--were both the Nebraska and the Omaha, two aircraft that even the most loyal Nebraskan no longer relies upon.

Move on to failures of airlines. Here's a list of 129 airlines that in the past 20 years filed for bankruptcy. Continental was smart enough to make that list twice. As of 1992, in fact--though the picture would have improved since then--the money that had been made since the dawn of aviation by all of this country's airline companies was zero. Absolutely zero.

Sizing all this up, I like to think that if I'd been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough--I owed this to future capitalists--to shoot him down. I mean, Karl Marx couldn't have done as much damage to capitalists as Orville did.

I won't dwell on other glamorous businesses that dramatically changed our lives but concurrently failed to deliver rewards to U.S. investors: the manufacture of radios and televisions, for example. But I will draw a lesson from these businesses: The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.

This talk of 17-year periods makes me think--incongruously, I admit--of 17-year locusts [pictured below]. What could a current brood of these critters, scheduled to take flight in 2016, expect to encounter? I see them entering a world in which the public is less euphoric about stocks than it is now. Naturally, investors will be feeling disappointment--but only because they started out expecting too much.

Grumpy or not, they will have by then grown considerably wealthier, simply because the American business establishment that they own will have been chugging along, increasing its profits by 3% annually in real terms. Best of all, the rewards from this creation of wealth will have flowed through to Americans in general, who will be enjoying a far higher standard of living than they do today. That wouldn't be a bad world at all--even if it doesn't measure up to what investors got used to in the 17 years just passed.