(#stocks , #investing , #warrenbuffett)
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The Warren Buffett indicator is used by Warren Buffett to determine whether the stock market is overvalued or undervalued. Warren Buffett is universally regarded as the greatest investor ever. A large part of his success has been him being able to know whether or not it is a good time to invest in the stock market. He has been able to avoid getting caught up in stock market bubbles. He is able to wait patiently on the sidelines until a crash happens, then buy up tens of billions of dollars in stock for huge discounts. While Buffett is called the Oracle of Omaha, it isn’t just pure intuition that allows him to seemingly time the market so well. It is backed up by cold hard numbers. The metric that Buffett uses to evaluate the stock market has become known as the Buffett Indicator.
The Buffett indicator is a way to help evaluate whether the stock market is undervalued or overvalued by comparing the value of stocks to that of a country's economy. Buffett has even gone as far as to say this is the single greatest measure of where valuations in the stock market stand at any given moment. Here’s how the Buffett Indicator is calculated. In the numerator of the fraction, we have the value of all stocks in the United States. This is the current value of the Wilshire 5000 Total Market Index. This is an index that includes all publicly traded stocks. As of the making of this video, the index consists of the 3,218 stocks that are publicly traded in America. Think of this as the current value of the stock market. On the bottom of the fraction, we have America’s Gross Domestic Product, or GDP for short. Simply put, Gross Domestic Product is the total value of the goods and services produced by a country in a specific period of time. Think of GDP as a measure of the size of an economy. The larger the GDP, the larger the economy. Once you divide the value of the entire stock market by the size of the economy, you then multiply that number by 100 to get a percentage. The higher the percentage, the more expensive the stock market is. The lower the percentage, the cheaper the stock market is and in theory, the better the time to buy stocks.
Think of the Buffett indicator as almost like a PE ratio of a stock. A PE ratio is calculated by taking a company’s stock price and dividing it by its earnings per share. So If a company’s stock is trading at $30 a share and it did $2 in earnings per share, the PE ratio is 15. The same basic logic applies to the Buffett indicator. Instead of the price of one stock, the Buffett indicator uses the value of all stocks in the top of the equation. Instead of earnings per share, it is the total value of the economy. It makes sense that the size of the economy is used because the profitability of the stock market as a whole is directly tied to the health of the economy. As the economy grows, it’s better for the companies that operate in that economy. A larger economy means there are more opportunities for companies to sell their goods and services and make more money for investors.