Classic Reread: Warren Buffett's 1999 Article in Fortune Magazine: How to Think About Investing in Technology

In 1999, investors at that time could be simply divided into two categories: (1) the successful ones who rode the wave of the Internet and could do anything, and (2) the "laggards" who failed to catch the Internet boom and were left far behind by the market.

Similar to the current AI boom, that year saw a fierce debate between the camps of "Internet bubble theory" and "You’ve been abandoned by the times." Both sides claimed rationality from their own perspective.

Let’s go back to 1999—In July of that year, the leading figure of traditional value investing, Warren Buffett published a classic article in Fortune magazine. In this piece, Buffett explained why investors might be too optimistic in their return expectations regarding new technologies.

He was not as passionate as other market commentators but instead used historical analysis and fundamental principles to argue why investors’ high expectations about the future, especially those driven by new technological changes, might be overly optimistic at the time.

Of course, from today’s perspective, we already know that eight months after that article, the Internet bubble burst, and countless fortunes were wiped out. This makes it even more worthwhile to see, at that time and faced with new technology, how top investors like Buffett thought about these issues. We can also observe how, in the lure of a bubble and the seemingly bright future, Buffett made his choices.

Buffett on the Stock Market

Today’s stock market investors have overly high expectations. Let me explain why…What I am about to say—if correct—will affect the long-term returns that American shareholders can expect in the future.

First, let’s define“investment”. The definition is simple yet often forgotten: to invest is to forgo money now in order to receive more back in the future—specifically, to have more purchasing power after accounting for inflation.

To gain some historical perspective, let’s review the past34 years of stock market performance. First, let’s look at the first17 years, from the end of1964 to1981.

Dow Jones Industrial Average
December 31, 1964: 874.12 points
December 31, 1981: 875.00 points

As everyone knows, I am a long-term investor and a patient one, but for such a long period, for the index to have almost no change is certainly unsatisfactory.

In stark contrast: during those17 years, US GDP grew almost fivefold, a gain of370%…but the Dow remained flat.

To understand why, we must first look at one of the two key variables affecting investment outcomes: interest rates. The effect of interest rates on financial asset valuation is like gravity on objects: the higher the rates, the greater the downward pull.

From1964-1981, long-term government bond rates soared, rising from just over4% at the end of1964 to over15% by the end of1981. The rise in rates dramatically suppressed the value of all investments…Thus, a tripling of the “gravity” of interest rates explains well why the economy surged yet the market stagnated.

Additionally, in the early1980s, the situation reversed…Let’s see what happened over the next17 years in the stock market: If you had invested$1,000,000 in the Dow Jones and reinvested all dividends onNovember 16, 1981, byDecember 31, 1998, you would have ended up with$19,720,112, an annualized return of19%.

During those17 years, the second factor affecting stock prices was after-tax corporate profits as a percentage of GDP.

However, by1981, this trend approached its low. In1982, profit growth fell to3.5%. Consequently, investors at that time faced two serious negatives: below-average profits and sky-high interest rates.

So, what happened during the17 years starting in1982? There was no similarly explosive GDP growth: in this second period, GDP grew less than threefold. But as interest rates started to fall, with the Paul Volcker effect receding, profits began to climb…These two dramatic shifts in the fundamentals most important for investors largely explain the more than tenfold increase in the market during these17 years—with the Dow rising from875 to9181 points.

Of course, market psychology also plays a role. Once a bull market starts,a crowd gets drawn in—not because they respond to rates or profits, but simply because not holding stocks seems a mistake. In fact, these people add an extra “I must not miss the party” factor on top of the fundamental drivers of the market.

Today, most investors look backward and nurture high hopes. A July survey from PaineWebber and Gallup found that the least experienced investors (less than5 years) expected annualized returns as high as22.6% over the next decade. Even those with more than20 years’ investment experience expected12.9%.

But I want to talk about what I see as the downside risk—the mathematical expectation, which is much lower than those predictions.

…Returning to my earlier point: there are three possible factors that might provide investors handsome returns in the future.

The first is that interest rates might fall.

The second is that after-tax corporate profits as a percentage of GDP could increase significantly.

Now for the third point: Perhaps you’re an optimist and believe that even if investors as a whole stumble, you will be among the winners. Especially in the early stages of the information revolution (which I wholeheartedly believe in), this idea is especially enticing.I think it is instructive to revisit several industries that transformed the country early in this century: the auto and aviation industries…

In total, the US has had at least2,000 car brands in its history, an industry deeply transformative to daily life. If you had foreseen in the early days of the automobile age how the industry would develop, you’d have said:“This is the way to get rich.” But by the1990s, what was left? After an unending cycle of company reshuffles, America had only three car manufacturers left—and even they were not“big winners” for investors. So, this was an industry with an enormous impact on America—and an enormous impact on investors—but not in the way they anticipated.

Incidentally, in these transformative events, picking losers was often much easier. You might have grasped the importance of the automobile industry but still struggled to pick a company that would make you money. But you could have easily made one obvious choice at the time: short horses.

During the first quarter century of this century, aside from the automobile, another truly transformative business innovation was the airplane—again an industry with a dazzling future that made investors salivate. But when I searched through aircraft manufacturing history, I found that between1919–1939, there were about300 companies. Now, only a few remain in operation.

Consider the failures among airlines. I have a list of the129 airlines that filed for bankruptcy in the last20 years. Continental Airlines was "smart" enough to be listed twice. In fact, as of1992—though things improved somewhat thereafter—since the birth of aviation, the total profits of all American airlines added together was zero.

Absolutely zero

I won’t dwell any further on other enticing sectors that radically altered our lives but failed to yield returns for US investors, such as the manufacture of radios and televisions. But I will draw one lesson from these industries: the key to investing is not assessing how much impact an industry will have on society or how fast it will grow, but rather judging the competitive advantage of any given company, especially how durable that advantage is. It is products or services with a wide and sustainable “moat” that will deliver returns to investors.