Image source: The Motley Fool
Billionaire investor Warren Buffett has shared a lot of wisdom throughout his successful career. However, one gem to come off his desk is the Buffett Indicator – a simple comparison of the US stock market’s total value divided by US GDP.
As Buffett puts it, the indicator is “probably the best single measure of where valuations stand at any given moment”. And for value investors, knowing when the stock market is overpriced is a powerful advantage, even when relying only on index funds.
However, looking at the Buffett Indicator today might cause some concern.
US stocks are expensive
Historically, his Indicator has sat between 90% and 135%. This healthy range generally indicates that US stocks are fairly-to-slightly overvalued and presents an ideal window of opportunity to top up on investments. But following the tremendous artificial intelligence (AI)-driven returns of 2023 and 2024, the indicator’s been rising. So much so that it now sits at a whopping 207%!
That’s the highest it’s ever been since records began in the 1970s. And it’s even higher than the 194% peak seen in late 2021, right before US stocks experienced one of the most severe market corrections seen in over a decade.
That would certainly explain why Buffett and his team at investment vehicle Berkshire Hathaway have been busy selling stocks lately. In fact, the firm just marked its 11th consecutive quarter of being a net seller, with positions such as Bank of America, Citigroup, and Capital One all getting trimmed, or outright sold off.
So could another stock market downturn be just around the corner?
Panic isn’t a strategy
The stretched valuation of US stocks definitely creates cause for concern. However, there’s no guarantee a crash or correction will actually materialise. Therefore, panic selling everything today likely isn’t a sensible strategy, and it’s why Buffett, despite higher selling activity, still has plenty of capital invested in the US stock market. In fact, he recently added $549m of Domino’s Pizza (NASDAQ:DPZ) to its investment portfolio.
His investment thesis is relatively simple. As the world’s largest pizza delivery company, Domino’s runs a 99% franchised business model. Combining this with its recurring ingredient & supply chain revenue and its high-margin royalty income, the business is highly cash generative. And what’s more, the firm’s proven to be quite recession-resistant since people tend to eat pizza during both the good times and the bad.
Of course, Buffett still highlighted some notable risks. Rising labour and ingredient prices do put pressure on profit margins, and the general shift towards healthier dining could erode demand over time. Nevertheless, he sees ample long-term potential for steady gains here. And given his track record of success, investors may want to take a closer look.
Will the stock market crash in 2025?
There’s no way of knowing whether the stock market will take a nosedive later this year. Even with the Buffett Indicator at sky-high levels, Berkshire’s investment in Domino’s suggests there are still bargains to be found among US stocks.
Therefore, investors could be well served to follow in Buffett’s footsteps, not by panic-selling, but by trimming overvalued positions to maintain portfolio diversification and hunting for hidden bargains.
