Warren Buffett is an American investor, business tycoon, philanthropist, and the chairman and CEO of Berkshire Hathaway. He popularized one of the most favoured market indicators, the Buffett Indicator (BI). But what exactly it is and how does it work? At a time when experts are cautioning investors of a stock market bubble, let’s find out what the indicator says.
Crux of the Matter
What Is Buffett Indicator?
The indicator is called the Buffett indicator (BI) due to its popularization by Warren Buffett. BI is one of the most favoured market indicators. It can indicate whether a particular market is overvalued or undervalued, and can help in forecasting the market
Buffett indicator = Stock Market Capitalization/Gross Domestic Product
Understanding The Terms
Gross Domestic Product is the final value of the goods and services produced within the geographic boundaries of a country during a specified period of time, normally a year.
Stock Market Capitalization
It is the value of all the publicly traded companies calculated by multiplying the total number of shares (of each company) by the current share price (of each company).
How It Came Into Prominence?
The use of the stock market capitalization-to-GDP ratio increased in prominence after Warren Buffett once commented that it was “probably the best single measure of where valuations stand at any given moment.”
Inferring Buffett Indicator
Through the Buffett indicator, if investors find a stock market in an economy undervalued, they should ideally buy stocks in that market by selling stocks owned in an overvalued economy. That way, the valuation will be set right and the investor is likely to profit.
BI Of India
However, determining the valuation of the market depends on the historical average of the Buffet Indicator.
- For instance, Indian markets have had a BI Ratio of 75% on average and have rarely crossed 100%.
- The low ratio is attributed to India’s unorganized sector that is unlisted.
Rise In India’s BI Ratio
Because India’s historical average has been between 70 – 80%, a 98% BI Ratio is cautioning investors that the market is overvalued.
The market cap-to-GDP ratio has been volatile as it moved from 79% in FY19 to 56% of FY20 GDP in March 2020 and now stands at 98% of FY21 GDP.Motilal Oswal Securities
Markets Are High
Recently, the Indian benchmark index SENSEX touched the 50,000 mark for the first time. But the market has been spiralling downwards since then.
Summachar brings you this story in collaboration with Finmedium that can be found on Instagram at @finmedium and on the web here.
- Buffet founded The Giving Pledge in 2009 with Bill Gates, whereby billionaires pledge to give away at least half of their fortunes. As of August 2020, the pledge has 211 signatories from 23 countries with over $600 Billion in pledges.
- Value investing is an investment paradigm that involves buying securities that appear underpriced by some form of fundamental analysis. High-profile proponents of value investing, including Warren Buffett, have argued that the essence of value investing is buying stocks at less than their intrinsic value.
- According to the Forbes Global 2000 list and formula, Berkshire Hathaway is the eighth largest public company in the world, the tenth-largest conglomerate by revenue and the largest financial services company by revenue in the world.
- Current Market Valuation – Buffett Indicator
- Corporate Finance Institute – Market Cap to GDP Ratio (the Buffett Indicator)
- The Economic Times – Caution, Please! Buffett Indicator Says D-Street Is Priced To Perfection
- Guru Focus – Buffett Indicator: Global Stock Market Valuations and Expected Future Returns
- The Financial Express – Warren Buffett’s favourite stock market indicator moves above historical average in India