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Dejargoned:Buffettratio
Buffettratioiscalculatedbydividingthetotalmarketcapitalizationbythegrossnationalproduct
RajeshKumar
Conventionalwisdominthestockmarketisthatinvestorsshouldbuy
whenstocksarecheapandsellwhentheyareexpensive.Thisworks
bothattheindividualstocklevel,aswellasfortheoverallmarket.
Returnsofgoodstocksboughtatreasonablevaluationcanalsoget
affectediftheoverallmarketisfrothyandisdueforacorrection.One
ofthereasonsfortherecenttroubleintheChinesestockmarketwas
thatitwentupsharplyoverthepastoneyearandstocksbecame
overvalued.
HemantMishra/Mint
Therearevariouswaystomeasureifstocksortheoverallmarketare
underorovervalued.Onesuchmeasureisthepricetoearnings
ratio.However,atthemacrolevel,investorsalsolookatthetotal
marketcapitalizationofalllistedstocksinrelationtothegross
domesticproductorthegrossnationalproduct(GNP).Thisisalso
termedastheBuffettratioorBuffettindictor.
WHATISIT?
Buffettratio,namedafteroneofthemostsuccessfulinvestorsofourtime,WarrenBuffett,iscalculatedbydividingthetotalmarket
capitalization(TMC)bytheGNP.it(TMC/GNP)isprobablythebestsinglemeasureofwherevaluationsstandatanygivenmoment,
notedWarrenBuffettinanessaypublishedinFortunemagazinein2001(see:http://mintne.ws/1RnBk1H).
AccordingtoBuffett,marketsarefairlyvaluediftheTMCis7080%oftheGNP.Ifthepercentagerelationshipfallstothe70%or80%
area,buyingstocksislikelytoworkverywellforyou.Iftheratioapproaches200%asitdidin1999andapartof2000youareplaying
withfire,headdedintheabovementionedessay.
Goingbythisindicator,stocksintheUSwouldbeovervaluedatpresent.AccordingtoarecentreportbyBloomberg,marketcapitalizationof
UScompaniesisatabout120%oftheGNP.(See:http://mintne.ws/1HRlZC0.)MarketvalueofstocksinChinareached$10trillioninJune,
buthasnowfallenabout30%fromthetop.TheGDPofChinawasat$10.36trillionin2014,accordingtoWorldBankdata.InIndia,the
currentmarketcapitalizationisabout80%ofGDPand,accordingtothismeasure,isnotovervalued.
LIMITATIONS
Buffettratiogivesabroadideaaboutvaluationsatthemacrolevel.Forexample,ifthemarketvalueiscloseto200%oftheGDPasitwas
duringthetechnologybubbleintheUSin19992000itsdefinitelyasignoftrouble.
However,investorsshouldnotrelyononlyonemeasureinallconditions.InIndia,forinstance,alotofeconomicactivity,whichisrecorded
inthenationaloutput,isnotpartofthestockmarket.IflargestaterunorganizationssuchastheIndianRailwaysandtheIndiaPostwere
listedonthestockexchange,thetotalmarketcapitalizationwouldhavebeensignificantlyhigher.Butyes,atthebroaderlevel,theBuffett
ratioisanindicationofwhethermarketsareinlinewithfundamentalsornot.
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