Buffet dixit

Enrique Diaz-Alvarez enrique at anise.ee.cornell.edu
Mon Nov 1 19:51:21 PST 1999

Excellent stuff by Warren Buffet. Then again, we already knew all this, didn't we?

The article is at:


Doug, did you send him a copy of your book? He's the only mainstream commentator I know who dares talk about the financial industry's take as essentially dead weight, instead of blabbing about "increased financial productivity".

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


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


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


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