Should You Buy Stocks With the Market at Record-High Valuations?

The S&P 500 has seen significant gains over the past two years, largely due to investors flocking to growth stocks in hopes of capitalizing on the benefits of a low interest rate environment. Growth companies tend to thrive in such conditions as they can borrow more easily to fuel their development and expansion. A robust economy also provides consumers with more disposable income to spend on the products and services offered by these companies.

In a bullish market, investing in growth stocks seems appealing, with impressive returns over the past two years. However, this strong performance has also led to a downside: higher stock valuations.

Current stock prices have risen dramatically compared to just a few years ago, reaching all-time highs. This situation raises an important question: should you still consider buying stocks at these elevated levels? To gain insight into this question, let’s see what renowned investor Warren Buffett is currently doing.

Buffett's Approach to Long-Term Investing and Value

Many investors look to Warren Buffett because of his proven understanding of the stock market and his historical ability to deliver substantial returns. Over his long tenure as chairman of Berkshire Hathaway, he has achieved an impressive compounded annual growth rate of almost 20% over 59 years, outperforming the S&P 500, which has shown a 10% increase over the same period. His strategy revolves around investing in industries and companies he understands, maintaining long positions, and prioritizing reasonable stock prices.

Buffett is often referred to as the archetypal value investor, meaning he seeks to buy shares of companies when they are undervalued relative to their intrinsic worth. The goal is to acquire stocks at a bargain price, with the belief that the broader market will eventually recognize the company's true value, leading to price increases and profit for early investors.

Looking at the current market landscape, the S&P 500 has risen significantly, but there are also growing concerns regarding variables like consumer spending and trade impacts stemming from government tariffs. Since mid-February, the index has even seen some declines, indicating potential instability.

An Expensive Market

As stock prices have climbed, valuations have also increased notably. One key indicator to assess stock valuations is the S&P 500 Shiller CAPE (Cyclically Adjusted Price-to-Earnings) ratio, which smooths out earnings and stock prices over a decade to accommodate economic fluctuations. This measure has recently surpassed the level of 37, a threshold that indicates stocks are exceptionally valued—something seen only twice since the S&P 500 was composed of 500 companies in the late 1950s.

Now, let’s examine Buffett's recent actions regarding stock purchases. In the past year, rather than buying stocks aggressively, he ended up being a net seller, selling off about $134 billion worth of stocks, including significant reductions in his stakes in large companies such as Apple and Bank of America, where he cut his holdings by 67% and 34%, respectively.

These moves helped Berkshire Hathaway achieve a remarkable cash position of over $334 billion. In a letter to shareholders, Buffett mentioned, "Often, nothing looks compelling; very infrequently we find ourselves knee-deep in opportunities." This suggests that he didn't see many attractive investment opportunities last year, which aligns with his value-focused strategy amidst the current market valuations.

How to Emulate Buffett's Investing Style

So, should you follow Buffett's lead by avoiding stock purchases at this time? Not necessarily. His hesitance doesn't imply he has abandoned all stock investing. In fact, he still maintains a close watch on the market and selectively invests when he finds value. For example, in the fourth quarter of last year, he initiated a new investment in Constellation Brands and increased his stake in Domino's Pizza by over 86%. Both of these companies are currently trading at more attractive valuations compared to their previous forward earnings estimates.

Buffett's strategy demonstrates that even in an expensive market, buying opportunities can still exist. While you may be hesitant to make investments due to high valuations, avoiding the market entirely could result in missed opportunities that can lead to wealth. Buffett's cautious approach still keeps him in equities—his recent shareholder letter reinforced this by stating, "Despite what some commentators currently view as an extraordinary cash position at Berkshire, the great majority of your money remains in equities. That preference won't change."

Ultimately, Buffett’s strategy remains focused on identifying stocks to buy and hold, regardless of market conditions. This disciplined approach has contributed to his long-standing success, and it may also guide other investors toward achieving similar victories in their financial journeys.

Stocks, Investing, WarrenBuffett