November 28, 2021

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Warren Buffett’s Market Indicator Rises Above 130%

On Friday, the day before Berkshire Hathaway Inc.’s (NYSE:BRK.A)(NYSE:BRK.B) annual shareholder meeting, Warren Buffett (Trades, Portfolio)’s favorite market indicator stood at 132.4%, up 18.8% from the April 1 level of 113.6% yet 18.9% below the December 2019 high of 151.3%.


Dow starts May lower as Apple and Amazon updates June-quarter plans amid coronavirus

The Dow Jones Industrial Average traded at an intraday low of 23,731.33, down 614.39 points from Thursday’s close of 24,345.72 on the heels of Inc. (NASDAQ:AMZN), a holding of Berkshire, announcing in a first-quarter earnings release that the Seattle-based e-commerce giant plans to spend its entire expected second-quarter operating profit of $4 billion on coronavirus-related expenses “getting products to customers and keeping employees safe,” according to CEO Jeff Bezos.


Likewise, Apple Inc. (NASDAQ:AAPL), the top holding of Berkshire based on the December 2019 13-F filing, said on Wednesday that due to the uncertainty regarding the virus, the Cupertino, California-based tech giant skipped its June-quarter earnings guidance despite reporting adjusted earnings that topped consensus estimates.


Market is coming off strong month of April, Buffett indicator rises back above 130%

The Dow Jones advanced over 11% during the month of April on hopes for a potential treatment of the Covid-19 virus and the reopening of the economy as the number of new cases starts declining.


As the markets rise from the all-time lows during late March, the ratio of total market cap to gross domestic product soared above 130%, yet is still approximately 20% below the all-time high.


Based on the current market valuation level, the expected market return over the next eight years is approximately -0.4% per year assuming a reversion to the mean level of 80%. According to the predicted and actual returns chart, the expected return ranges from -8.2% per year in the most-pessimistic case to 4.50% in the most-optimistic case.

GuruFocus’ Interactive Chart allows users to visualize historical valuations

The following video explores how GuruFocus Premium users can visualize historical valuations using the Interactive Chart. Two key built-in chart templates are the Peter Lynch Chart and the price-sales valuation bands chart.

Legendary investor Peter Lynch, who managed the Fidelity Magellan Fund during the 1980s, developed a quick way to determine if a stock is undervalued or overvalued: Compare the price line to an earnings line based on a price-earnings ratio of 15. Figure 1 illustrates a sample Peter Lynch Chart for Coca-Cola Co. (NYSE:KO), Berkshire’s third-largest holding as of the December 2019 filing.


Figure 1

As Figure 1 illustrates, Coca-Cola’s price line is above the Peter Lynch earnings line, suggesting possible overvaluation.

Lynch warned that cyclical companies like Amazon and Apple might have high profit margins at the peak of business cycles, resulting in artificially-low price-earnings ratios. Coca-Cola, on the other hand, is in the consumer defensive sector and thus the Atlanta-based beverage company’s profit margins are not as sensitive to changes in the business cycle.

Unlike the price-earnings ratio, the price-sales ratio is less impacted by cyclicality and, therefore, more accurately compares current valuations to historical valuations. Buffett’s market indicator of total market cap to gross domestic product is like a price-sales ratio, with the total market cap representing the price of the U.S. market and gross domestic product as the total sales of the U.S. market. Figure 2 illustrates a sample price-sales valuation bands chart for Apple.


Figure 2

As Figure 2 illustrates, Apple’s price line is near the midpoint of the two valuation bands, suggesting fair valuation.

Disclosure: The author is long Apple as of this writing. The discussion of Berkshire’s portfolio holdings in this article is based on the conglomerate’s December 2019 13-F and does not consider any trades made during the first quarter of 2020. Per Securities and Exchange Commission regulations, the deadline to report quarterly portfolios is 45 days after the quarter ends.

Read more here:

  • Video: Tracking Warren Buffett’s Trades Using GURUG
  • Video: 4 Large-Cap Stocks With Strong Buffett-Munger Characteristics
  • Warren Buffett’s Market Indicator Falls Near 3-Year Low

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This article first appeared on GuruFocus.

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