On Monday, Warren Buffett (Trades, Portfolio)’s favorite market indicator reached 144.4%, approximately 4.1% from its all-time high. Apple Inc. (AAPL, Financial), Buffett’s top holding, set a new intraday high in morning trading.
Buffett’s market indicator remains above 140%
The Berkshire Hathaway Inc. (BRK.A, Financial)(BRK.B, Financial) CEO mentioned that the ratio of the Wilshire 5000 full-cap index to the U.S. gross domestic product is “probably the best single measure of where market valuations stand at any given moment.” As of 11 a.m., the total market index is approximately 1.444 times greater than the U.S. GDP. Based on this market valuation level, the U.S. market is expected to return -2.2% per year over the next eight years.
Figure 1 shows the historical trends of the index and GDP, while Figure 2 shows the historical trend of the Buffett indicator.
Figure 1
Figure 2
The predicted market return includes three components: the dividend yield, the business growth rate and the change in the market return. We compute the change in the market return as the ratio of the ending market ratio to the current market ratio raised to the one-eight power less one: (Re/Rb)^(1/8)-1. We set the period to eight years, approximately the length of a full economic cycle.
Figure 3 illustrates three cases for the ending market ratio: an optimistic case of 120%, an expected case of 80% and a pessimistic case of 40%. According to Figure 3, the expected market return ranges from -9.9% to 2.6%.
Figure 3
Apple sets new intraday high
At 11:30 a.m., Apple set a new intraday high of $208.93, approximately 19 cents higher than its 52-week high of $208.74. The company eclipsed the $1 trillion market cap level on Aug. 2 on strong net sales for its key products, including the iPhone and Apple Watch. GuruFocus ranks Apple’s profitability 8 out of 10 and business predictability 2.5 stars out of five. Figure 4 shows the Apple’s revenue and earnings trends over the past 10 years.
Figure 4
Markel Corp. (MKL, Financial) co-CEO and portfolio manager Tom Gayner (Trades, Portfolio) added 8,770 shares of Apple according to his second-quarter portfolio report filing. Apple averaged $181.31 during the quarter: the guru is gaining approximately 55% on the stock based on GuruFocus estimates.
See also
Other market valuation metrics, including the Shiller price-earnings ratio and the Tobin Q ratio suggest that the U.S. market is significantly overvalued. As of noon, Robert Shiller’s cyclically adjusted price-earnings ratio stands at 32.6, approximately 93% higher than the historical mean of 16.9 as Figure 5 illustrates.
Figure 5
According to the economic indicator pages, Tobin’s Q-ratio measures the ratio of the market value of a company to the company’s assets. According to Figure 6, the Q-ratio for the U.S. market as of first-quarter 2018 is 1.1, implying moderate overvaluation.
Figure 6
Buffett and co-CEO Charlie Munger (Trades, Portfolio) underscored four key criteria for good companies: predictable earnings, expanding profit margins, no meaningful debt and attractive prices. GuruFocus listed several model portfolios that have outperformed the benchmark over the past 10 years, including the “Most Broadly Held” portfolio and the “Undervalued Predictable Companies” portfolio. Premium users can view the stock lists that correspond to the above portfolios: the Aggregated Portfolio of Gurus and the Undervalued Predictable Screener.
Disclosure: No positions.
