The Buffett Ratio

Within the value investing community, there is a consensus that it is impossible to time market and entry with any degree of success. The best investors can try to do is to develop some tools to gain an overall sense of the level of valuation of the market, and try to base their investment decisions on them.

In an earlier post, I had written about the Market P/E ratio and how it can help investors to get an overview about where the market stands as compared to its historical valuations. In this article, I would like to discuss the Market Cap/ GDP ratio, popularly known as the Buffett Ratio.


This is how it is calculated:


When market valuations reach very high levels, the ratio crosses 100%, implying that the market's valuation is greater than the value of all goods and services produced by the economy in the year just gone by. Given that the stock market is but an aggregation of the underlying businesses which make up the economy, it is a sign of high optimism when the market's valuation crosses the country's GDP.

One of the fundamental rules of value investing is to invest only when the asset being acquired is available at a discount to its intrinsic values. The Buffett Ratio gives an idea of how expensive or inexpensive the market as a whole is.

Traditionally, value investors have focused on the valuations of individual stocks, and not given too much attention to the state of the economy as a whole. But, in the wake of the Great Recession just past us, there is renewed interest among them to incorporate some techniques which give an indication of where in the business cycle the economy is, and whether the stock market is keeping up with this or whether it has overshot fundamentals.

The following graphs are available here and are updated regularly, so the information shown here is up-to-date.

Latest Graph of US GDP & Market Capitalisation



Latest US GDP/ Market Cap Ratio