Buffett "Weighing Machine Metric": Time to Buy Stocks

A metric that Warren Buffett uses to assess the market’s valuation is now showing that it is a good time to buy stocks, Carol Loomis and Doris Burke write for Fortune.

Source: Fortune/CNNMoney.com

According to Loomis and Burke, Buffett believes that over the long term, there should be a “rational relationship between the total market value of U.S. stocks and the output of the U.S. economy (gross national product).” If the total stock market value as a percentage of GNP falls to the 70 to 80 percent range, Buffett has said, buying stocks is likely to work out very well for investors.

As of late January, stocks were 75 percent of U.S. GNP, right in that target range Buffett cited, note Loomis and Burke.

Buffett’s theory has worked out well before. Fortune first discussed Buffett’s stock market value vs. GNP theory back in late 2001. At that time, stocks had already tumbled from their 2000 highs, but their market value was still 133 percent of GNP — indicating the market was overvalued. Over the next ten months, the S&P 500 lost another 32 percent before bottoming.

Loomis and Burke make an interesting point about the GNP-stock value relationship: “Nothing about that reversion to sanity [in valuations] surprises Buffett, who told Fortune that the shift in the ratio reminds him of investor Ben Graham’s statement about the stock market: ‘In the short run it’s a voting machine, but in the long run it’s a weighing machine.'” Translation: In the short term, stocks fluctuate based on the day-to-day whims of investors — the voting machine. But over the long haul, what really ends up driving a stock’s price is the value of its underlying business — the weighing machine.

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