In November 1999, Warren Buffett dropped a bombshell on investors when he wrote (with Carol Loomis) in Fortune magazine that the most likely average annual returns for investors in the market for the following 17 years would be 4%.

You may recall that at the time, market participants were enjoying their fifth straight year of better-than-20% returns. As the article noted, polls taken at the time showed those who had been investing for less than five years were expecting annual returns over the next 10 years of ... drum roll, please ... more than 22%! Even investors with 20 years of experience were expecting annual returns of 13%.

The triumph of the pessimists
Buffett argued rationally that such returns were not mathematically achievable, barring occurrences such as long-term interest rates going from 6% (where they were at the time) to 1%, or corporate profits expanding well beyond their historical percentage of gross domestic product. Buffett postulated that when factoring in 1% average annual expense costs, real realized returns to investors should be about 4%. Including 2% annual inflation, nominal returns could be 6%.

The article was based on a speech that Buffett made in July 1999, a time when the S&P 500 was sitting at 1,420.

Last fall, to much ballyhoo, the S&P 500 hit new highs, but following recent market action the S&P now has returned to roughly 1,420, meaning that it's done nothing in terms of capital gains since the time of Buffett's speech eight and a half years ago.

"Nothing is good or bad, but thinking makes it so"
Let's unlock what is unquestionably good news from the lack of movement in stock prices during the past eight years.

Sure, investors who've been in the market all that time have had a couple of wild rides to merely get back to just a little bit higher than where they started. But during the past seven years, three key things have happened:

  1. Real corporate profits have actually grown faster than the 3% Buffett hypothesized.
  2. Long-term interest rates are no higher than they were in 1999.
  3. Inflation has not been noticeably worse than expected.

So, the fundamental driver of stock returns -- real corporate earnings per share -- has been slightly better than what Buffett imagined. What's dramatically improved, however -- with better fundamentals at the same price -- is the valuation of stocks, particularly the large-cap stocks that Buffett was talking about.

We need an example. Let's look at the rough valuations of some of the S&P 500's main components in 1999 and today:


Average 1999 P/E

Current P/E

Bank of America (NYSE: BAC)






Lowe's (NYSE: LOW)



Occidental Petroleum (NYSE: OXY)



Texas Instruments



Intel (Nasdaq: INTC)



Heinz (NYSE: HNZ)



Altria (NYSE: MO)



S&P 500 average



Data from Capital IQ, a division of Standard & Poor's.

So where does this leave us? The economy -- and by my calculations, the performance of companies in terms of profits -- has exceeded what Buffett posited. Not wildly exceeded, mind you, but there was a slight edge. That result could turn out to be ephemeral, especially as corporate profits as a percentage of GDP are now very high by historical standards. If they return to the midpoint of their historical range while the economy grows at its usual rate, then after-tax earnings growth will decline.

What lies ahead
I thought I'd run the numbers on what Buffett's original estimate would mean for the remaining eight and a half years or so of his 17-year forecast.

During the past eight and a half years, the market has returned essentially 0% in terms of capital gains if you're measuring with the S&P 500 -- a bit better if you measure by the Dow Jones Industrial Average. Dividends have been on the order of about 1.6%, on average, and inflation has been 2.7% annually. So real returns have been negative to the tune of about 1%. For real market returns of 5% annually over the 17 year estimate period (ignoring, for the moment, the costs of investing) to materialize by 2016, we would need to see roughly 11% real returns over the next eight and a half years.

Wait, 11% in real terms? That would be phenomenal. The historic average real returns of the market have been about 6.5% over the past 100 years. So are 11% real returns possible? Would Buffett really predict those types of 10-year returns today?

I highly doubt it. And I'm certainly not going to put words into Buffett's mouth, because I'm pretty sure he -- or Charlie Munger -- would kick my butt for doing so. Literally. Which would be embarrassing. Especially if somebody then posted a video of it on YouTube or something. Which always seems to happen nowadays. But I digress.

The long stagnation of stock prices -- during a time when corporate profitability accelerated and companies bought back record levels of stock and dramatically beefed up their balance sheets -- certainly means there's a great deal more of a margin of safety today than there was in 1999.

Going beyond the S&P
Now might be a great time to get into the market. But, as is always the case -- and certainly as the past eight years have reminded us -- we approach this as long-term investors. One way to jump in is with a broad-market index fund. But if you'd like to do a little better than the index, and you need some help picking market-beating stocks, consider joining our flagship Motley Fool Stock Advisor service. Since 2002, Fool co-founders David and Tom Gardner have produced 63% returns versus the market's 23%. You can grab a free 30-day trial right now by clicking here -- now might be a pretty good time for one.

This article was originally published Aug. 9, 2006. It has been updated.

Bill Barker does not own shares of any company mentioned in this article. Microsoft and Intel are Motley Fool Inside Value picks. Bank of America and Heinz are Income Investor picks. If you squint real hard, the Fool's disclosure policy looks a bit like a young M. Emmet Walsh.