Billionaire Warren Buffett's Favorite Valuation Tool Just Made Dubious History -- and It Couldn't Be Worse News for Wall Street

Yahoo

7 hours ago

Warren Buffett's outsized investment returns at Berkshire Hathaway have made him Wall Street's most-followed money manager.
Stocks are historically pricey, and the affably-named "Buffett Indicator" proves it.
However, Buffett would never suggest betting against America and has positioned Berkshire's $296 billion investment portfolio and owned assets for long-term success.
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For decades, billionaire Warren Buffett has been Wall Street's most-followed money manager -- and for good reason. In his six-decade stead as the CEO of Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B), the appropriately named "Oracle of Omaha" has overseen a cumulative return in his company's Class A shares (BRK.A) of 5,882,492%, through the closing bell on July 3. For context, this is over 140 times greater than the total return, including dividends, of the benchmark S&P 500 (SNPINDEX: ^GSPC) over 60 years.
In addition to running circles around the S&P 500 over extended periods, Buffett's willingness to share his investment experiences and the traits he looks for in businesses has endeared him to the investing community. There's a reason around 40,000 people flock to Omaha annually to hear Berkshire's CEO offer remarks about the U.S. economy, stock market, and occasionally his company's investment holdings.
But the unpleasant truth for Wall Street is that Buffett's words and/or actions don't always mesh with the buy-and-hold philosophy that's become synonymous with Berkshire Hathaway's nearly $296 billion investment portfolio.
Worse yet, the valuation tool Berkshire's billionaire chief once held near and dear is making dubious history.
To preface any discussion on valuation, let's recognize that "value" is something of a subjective term. What one person views as expensive might be considered a bargain by another. This perspective of value is what makes the stock market a market.
When most investors are valuing a publicly traded company, they tend to rely on the price-to-earnings (P/E) ratio. This traditional valuation measure divides a company's share price by its trailing-12-month earnings per share. It's a quick way to size up mature businesses, but it's not the most accurate tool during economic downturns or for growth stocks.
However, the traditional P/E ratio isn't, necessarily, the go-to valuation tool for billionaire Warren Buffett.
In a rare interview granted to Fortune magazine in 2001, Berkshire's billionaire chief described the market cap-to-GDP ratio as, "probably the best single measure of where valuations stand at any given moment." This measure, which has come to be known as the "Buffett Indicator," adds up the value of all publicly traded companies and divides it by U.S. gross domestic product (GDP).
When back-tested 55 years to 1970, the Buffett Indicator has averaged a reading of 85%. In other words, the cumulative value of publicly traded companies has equated to 85% of U.S. GDP. But as you can see from the post above on X (formerly Twitter), the Buffett Indicator has surged to a fresh all-time high.
As of the closing bell on July 2, the Buffett Indicator hit 209.53%, which is roughly a 147% premium to its 55-year average.
The implication here is very simple: Stocks are exceptionally pricey. When equities are pricey, the Oracle of Omaha has demonstrated a willingness to pare down Berkshire Hathaway's exposure and/or sit on his proverbial hands until attractive deals reveal themselves.
Perhaps unsurprisingly, Berkshire's consolidated quarterly cash flow statements show Buffett has been a net seller of stocks for 10 consecutive quarters (Oct. 1, 2022 – March 31, 2025), totaling an aggregate of $174.4 billion. In fact, Buffett is such a stickler for getting a good deal that he's gone cold turkey on repurchasing shares of his favorite stock (Berkshire Hathaway) for three consecutive quarters.
The Buffett Indicator surging to almost 210% is terrible news for Wall Street in the sense that it signals value is becoming increasingly hard to come by. It also suggests Berkshire's brightest investment mind is going to continue to sit on his company's record-breaking cash pile of $347.7 billion (including U.S. Treasuries).
Getting a perceived deal when buying a company or taking a stake in a publicly traded business is an absolute must for billionaire Warren Buffett. But this isn't the only unbendable rule he lives by.
Even when stock valuations are historically unappealing, Berkshire's head honcho has no intention of ever better against Wall Street or America. In Berkshire Hathaway's 2021 annual letter to shareholders, Buffett penned:
Despite some severe interruptions, our country's economic progress has been breathtaking. Our unwavering conclusion: Never bet against America.
These four words, "never bet against America," signal Buffett's recognition of economic and stock market cycles, and his genius of positioning his company to take advantage of a simple numbers game.
Berkshire's chief and his top investment advisors are well aware that economic recessions are normal, healthy, and inevitable. But most importantly, Buffett recognizes the nonlinearity of economic cycles. Whereas the average U.S. recession has endured for just 10 months since the end of World War II, the typical economic expansion has stuck around for approximately five years. The disproportionate nature of these cycles has allowed U.S. GDP to meaningfully expand over time.
Perhaps it's no surprise that Berkshire's investment portfolio and the roughly five dozen companies that have been acquired since Buffett became CEO tend to be highly cyclical and benefit immensely from long-winded periods of economic growth.
The Oracle of Omaha also realizes that this nonlinearity applies to the stock market. Even though downturns are inevitable, they usually resolve quickly.
In June 2023, a data set published on X from Bespoke Investment Group showed the average S&P 500 bear market since the start of the Great Depression (September 1929) lasted only 286 calendar days, or about 9.5 months. In comparison, the typical S&P 500 bull market endured for 1,011 calendar days over this nearly 94-year-period. Wagering on high-quality companies to increase in value over time is a statistically smart move.
While a historically high Buffett Indicator is nothing short of damning to Wall Street over the short-term, an eventual correction or bear market will give way to phenomenal investment opportunities -- and Buffett or his successor Greg Abel will be there to take advantage of them.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.
Billionaire Warren Buffett's Favorite Valuation Tool Just Made Dubious History -- and It Couldn't Be Worse News for Wall Street was originally published by The Motley Fool