Market Capitalization to Gross Domestic Product Can’t Predict The Stock Market

When Warren Buffett started his investing career, he would respond to general questions about whether the stock market was overvalued or undervalued by pointing to the ratio between the market capitalization of American stocks and America’s GDP. If the market cap of all publicly traded American stocks exceeded the gross domestic product of what the nation produced (i.e. was a ratio over 100%), then the stock market would be considered overvalued. And if the ratio was below 100%, the stock market would be considered undervalued. Right now, the market cap to GDP ratio is 147%, which would historically suggest that stocks in aggregate trade at 1.5x their overall value based on Warren Buffett’s historically used benchmark. 

As you may have noticed, Warren Buffett has not cited this valuation benchmark in recent years.

I suspect there are at least two reasons why. 

As an initial matter, Benjamin Graham introduced the concept … Read the rest of this article!

Mental Anchoring And Investor Folly

When you build an ownership collection of the best companies in earth—I have in mind firms like Visa, Coca-Cola, Johnson & Johnson, and Chevron—there is a pleasant occurrence you can come to expect: These companies will regularly grow their profits, causing your calculations of the firm to constantly be subject to upward revision.

It came to my attention when I was in dialogue with a reader that had an average cost basis in Chevron stock somewhere around $63 or $64 per share, and couldn’t bring himself to pay $115 per share even though he thought the stock seemed like a good deal at the price. That’s a behavioral force worth examining—previous experience with a stock at a cheaper price can color your current perception of the company’s value now. It can have the effect of preventing you from making a good investment (into a company you already own) and lower … Read the rest of this article!