6.8 C
New York
Wednesday, November 30, 2022

Subscribe

Warren Buffett Still Isn’t Buying Stocks. Here’s Why…

Authored by Ven Ram, Bloomberg cross-asset strategist,

The legendary value investor Warren Buffett is, by and large, still shying away from buying US stocks despite the 20% slump in the S&P 500 Index this year.

That’s likely because a key metric that guides his investments is still at levels that he would perhaps consider too onerous and demanding, suggesting the backdrop is still not conducive for value investors.

The combined market capitalization of the universe of U.S. stocks as captured by the Wilshire 5000 Index totaled $37.96 trillion as of Tuesday’s close. That amounts to 148% of the $25.7 trillion value of U.S. gross domestic product at the end of the third quarter.

The ratio is now at levels that prevailed in the run-up to the first wave of the pandemic, when hardly anyone would have thought stocks offered true value

Buffett remarked once that buying stocks is “likely to work very well” when the percentage relationship is in the 80% area. With general valuations having soared since then and reasonably good investments coming with a stiff price tag, Buffett may have relaxed that threshold higher, but it’s unlikely that he would find the current valuations persuasive

While his holding company Berkshire Hathaway is doubtless making acquisitions at the margin, the company’s cash pile at the end of September was $109 billion, compared with $105.4 billion in June. In other words, with stock valuations still lofty, Buffett and his money managers are ostensibly finding little that interests them despite the slump in the S&P 500 and Nasdaq this year.

“I use it as one important value metric,” says Paul Ciampa, a fixed-income professor at Boston College.

“I also dig into profit margins (which are high). One could now argue (since PEs have fallen to average) that this is mainly due to profit margins being so high. A 12% margin falling to 9% would push things much closer to normal.”

An analysis of the S&P 500’s duration suggests that stocks will fall about 7.1% for every 100-basis point increase in the Fed funds rate, while the Nasdaq 100 will lose 9.6% of its value

Berkshire’s elusive quest to find value in stocks is hardly surprising.

For all the brouhaha about how much stocks have slumped, the price-to-book ratio of the S&P is still a demanding 3.8x and an even more punitive 5.8x for the Nasdaq 100. That’s not all: In an environment where two-year Treasuries offer a yield well north of 4.50%, the puny, below 2% dividend yields on the S&P and Nasdaq are hardly anything to write home about.

Assuming the cumulative dividends of the S&P 500’s constituents over the next 12 months add up to around $64 per share, the fair value implied by the Gordon growth model, assuming a rate of return of 7% on stocks and a growth rate of 5%, would be around 3,200.

Interest-rate traders are now factoring in a terminal rate that is above 5% for the Federal Reserve, which means that stocks are unlikely to go gangbusters anytime soon.

It’s clear that despite this year’s slump in stocks, we are barely anywhere in what may be called a value zone – which speaks in spades about how much they had been bid up during the ultra-low interest rates of the previous years. Alas, that means a quick rebound isn’t quite what the doctor ordered.

This post was originally published on this site

Subscribe
Notify of
0 Comments
Inline Feedbacks
View all comments

Stay Connected

159,624FansLike
407,724FollowersFollow
2,140SubscribersSubscribe

Latest Articles

0
Would love your thoughts, please comment.x
()
x