Warren Buffett’s recent investment decisions suggest he believes the stock market is overvalued. Berkshire Hathaway, the company Buffett leads, has been a net seller of stocks for the past seven quarters. The company’s net sales have totaled more than $150 billion during this period.
This indicates Buffett is having trouble finding reasonably priced stocks after the market’s recent surge. The S&P 500 is currently trading at 22 times forward earnings. This is higher than the five-year average of 19.6 times forward earnings.
High forward price-to-earnings ratios have historically been associated with poor long-term performance. Torsten Slok, Chief Economist at Apollo Global Management, says these ratios suggest the market will only return about 3% annually over the next three years. However, it’s important to put Buffett’s recent decisions in context.
Berkshire Hathaway’s massive size, with a market capitalization of $1 trillion, limits its investment options.
Buffett’s warning on market valuations
Buffett has also admitted to avoiding technology stocks because he doesn’t fully understand them.
These factors mean Berkshire has fewer opportunities to deploy large amounts of capital. In his latest shareholder letter, Buffett highlighted this issue, saying: “There remain only a handful of companies in this country capable of truly moving the needle at Berkshire, and they have been endlessly picked over by us and by others.”
Buffett also noted that international stocks present few viable options for Berkshire’s capital deployment. As a result, many stocks are historically expensive, making compelling investment opportunities increasingly rare.
For individual investors, the investment landscape is more diverse. Buffett’s warning shouldn’t be seen as a directive to completely avoid the market. Instead, it’s a reminder that valuations are important.
The current environment certainly calls for caution, as even a minor economic or political shock could trigger a market correction or bear market. However, avoiding the market entirely may not be a good idea. As legendary investor Peter Lynch famously said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
