With the stock market hitting all-time highs on many occasions last year, investors have debated for months whether it is overvalued. Some believe the artificial intelligence (AI) trade is powerful enough to cast valuations aside and propel the market higher because AI could be just as disruptive as the advent of the internet, or more.
Meanwhile, others say there's still a lot we don't know about AI, and valuations have gotten ahead of themselves. Berkshire Hathaway CEO Warren Buffett, who is one of the greatest investors ever, seemed to grow concerned about market fundamentals last year, sending deafening warnings to Wall Street.
But Buffett and Berkshire recently made moves that suggest there could be a silver lining to the Oracle of Omaha's pessimism over the past year.
Buffett's warning
In 2024, Buffett and his team clearly thought the stock market was overvalued. First, Berkshire stockpiled more cash than ever before. At the end of the third quarter, it had over $320 billion in cash and cash equivalents and short-term U.S. Treasury bills.
Furthermore, Berkshire sold way more stock than it bought, including big sales of its two largest positions, Apple and Bank of America. Through the first nine months of 2024, Berkshire only purchased $5.8 billion in stock and sold over $133 billion. It also repurchased only a few billion dollars of its own stock, way down from recent years.
Another indicator for Buffett is also flashing red. He looks at the ratio of stock market capitalization to gross domestic product (GDP) to see if the stock market is undervalued or overvalued. Historically, a ratio of 50% suggests the market is undervalued, while a ratio over 100% suggests the market is overvalued. This Buffett indicator recently surpassed 200%.
Buffett and Berkshire have a strong track record of timing the market and getting out at the right time. It's one of the reasons the stock has generated such extraordinary gains. Given all these factors, their warnings certainly reached deafening levels in 2024.
The silver lining
Those warning signs are firmly in effect today. However, the silver lining is that Berkshire has been buying stock. From mid- to late December, it poured over a half-billion dollars into several companies:
- Occidental Petroleum: 264.2 million shares, 28.2% of the company, and 4.2% of Berkshire's portfolio.
- Sirius XM Holdings: 117.5 million shares, 34.6% of the company, and 0.9% of Berkshire's portfolio
- VeriSign: 13.9 million shares, 13.8% of the company, and 1% of Berkshire's portfolio
Even though these were additions to existing positions, it's good to see Buffett and Berkshire buying because it suggests they still see opportunities. Market breadth was poor in 2024 as a few dozen high-flying tech and artificial intelligence stocks carried the market.
In 2024, 174 stocks in the broader benchmark S&P 500 ended the year in the red. Meanwhile, 348 stocks in the S&P 500 underperformed the benchmark's broader 23% gain. So perhaps Buffett is saying that you can still buy good companies at reasonable valuations.
All of Berkshire's recent purchases vastly underperformed the broader market last year, and all have forward price-to-earnings ratios (P/E) under 25, with VeriSign trading at roughly 24 times forward earnings, Occidental at less than 14, and Sirius around 7.
Underperformance and lower P/Es aren't necessarily flashing signs to buy. These valuations and sell-offs are often warranted. But you can bet Buffett and his team at Berkshire have done their homework on these stocks, and so can you.
You can still buy in an overvalued market. There is always opportunity, and value stocks may be more insulated during a market sell-off because investors already have low expectations. Just make sure to do your due diligence.
