Is it safe to buy stocks while the S&P 500 is at an all-time high? Warren Buffett’s advice can save investors from costly mistakes

By | April 2, 2024

The S&P500 (SNPINDEX: ^GSPC) Over the past year, yields have risen 31% as investors grew more confident of a soft landing, a scenario in which the Federal Reserve successfully reins in inflation without plunging the economy into recession. The index is currently within a percentage point of its record high, but upward momentum has pushed stock market valuations higher.

The S&P 500 currently trades at 20.9 times forward earnings, a slight premium to its five-year average of 19 times forward earnings, and a significant premium to its 10-year average of 17.7 times forward earnings. future profit. Not surprisingly, some Wall Street analysts think the stock is due for a correction. JPMorgan Chase And Morgan Stanley have set end targets for the S&P 500 of 4,200 and 4,500 respectively, implying a decline of 19% and 14% from current levels.

These predictions leave investors with a difficult decision to make. Is it safe to buy stocks while the S&P 500 is near its all-time high? Or is the stock market best avoided until valuations drop? Anyone looking for answers could follow Warren Buffett’s example.

What investors can learn from Berkshire Hathaway’s 13F filings

CEO Warren Buffett reportedly controls about 90% of total revenue Berkshire Hathaway‘S (NYSE: BRK.A)(NYSE: BRK.B) stock portfolio, while deputies Todd Combs and Ted Weschler handle the rest. Investors can track the stocks the trio buys and sells each quarter by reviewing the Form 13Fs the company files with the SEC.

The latest filing shows that Berkshire sold several stocks in the fourth quarter. The company closed its positions Markel, Globe life, DR. HortonAnd SteenCohas his positions in place Big global And PKand reduced his stake Apple (NASDAQ: AAPL). However, Berkshire also bought shares in the fourth quarter. The company expanded its positions in Sirius XM, Western petroleumAnd Chevron.

Collectively, Berkshire was a net seller of shares last year. The company reported more than $40 billion in stock sales, compared to just $16 billion in purchases. That marks a turnaround from the previous year, when Berkshire reported $33 billion in stock sales and $68 billion in purchases.

In short, Buffett and his deputies continued to buy stocks throughout 2023 despite rising valuations, but they also traded more cautiously. Investors should follow suit.

Warren Buffett’s blueprint for successful investing

Over the years, Warren Buffett has dropped bits of investment advice like breadcrumbs during interviews, editorials and shareholder letters. In synthesizing that information, the overriding theme is that Buffett likes to buy understandable companies that benefit from a sustainable economic moat, but only if shares trade at attractive prices relative to intrinsic value.

Economic moats come in different shapes and sizes, but they generally boil down to pricing power or cost advantages. Apple, for example, derives its pricing power from the brand authority it has built up with consumers. Nvidia has pricing power due to the superior nature of its artificial intelligence chips. And Visa benefits from cost advantages resulting from the size of its payment network. However, an economic moat alone does not qualify a company as a good investment. Investors should also consider its valuation.

Buffett once explained the concept of intrinsic value by quoting economist John Burr Williams: “The value of any stock, bond or company today is determined by the inflows and outflows of cash – discounted at an appropriate interest rate – of which can be expected to occur over the remaining life of the asset.” That quote refers to discounted cash flow analysis, in which future earnings are discounted to their current value to estimate what a company is worth.

How the discounted cash flow calculation works

The discounted cash flow (DCF) formula looks intimidating on paper. But online calculators can crunch the numbers, so investors just need to familiarize themselves with the inputs. Learning by example is the best strategy. Below is a DCF calculation for Apple using this calculator.

  • Current value: The earnings per share (EPS) or free cash flow (FCF) per share over the last twelve months. I used the earnings per share of €6.42 over the last twelve months.

  • Discount percentage: The return needed to make the investment worthwhile. I used the historical return of the S&P 500, which is about 10% annually. Some investors prefer the weighted average cost of capital.

  • Growth percentage: The expected profit growth rate over a certain period of time. I used the consensus forecast among Wall Street analysts, which says that Apple will grow earnings per share at 8.3% per year over the next five years.

  • Grow Beyond: The length of time the growth rate will continue. As mentioned, Wall Street expects Apple to grow earnings per share at an annual rate of 8.3% over the next five years.

  • Final rate: The expected earnings growth rate after the explicit forecast period. This figure should be in line with inflation, but should not exceed gross domestic product growth. Investors typically select a value between 2% and 4%, so I split the difference by 3%.

  • Final rate above: The length of time the final rate will remain in effect. Investors often assume that terminal growth will continue indefinitely, but I assumed 50 years.

Based on this data, Apple is currently worth $115 per share. That means the stock is about 32% overvalued at its current price of $169 per share. However, investors should remember that DCF models involve guesswork, and even small changes in inputs can have a drastic impact on output.

It is safe to buy stocks, but market conditions require caution

In summary, the S&P 500 has soared much higher over the past year and the index is currently trading at a significant premium to its historical valuation. Yet Buffett continued to buy shares throughout the year, including during the fourth quarter. But he also showed more caution compared to the previous year, indicating that valuable investments were harder to find.

In that context, investors can safely buy shares in the current market, provided they exercise the same caution. That means avoiding costly mistakes that arise from the fear of missing out, and instead limiting purchases to companies with competitive advantages that trade at reasonable valuations.

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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennevine has positions in Nvidia and Visa. The Motley Fool holds positions in and recommends Apple, Berkshire Hathaway, Chevron, HP, JPMorgan Chase, Markel Group, Nvidia, StoneCo and Visa. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy.

Is it safe to buy stocks while the S&P 500 is at an all-time high? Warren Buffett’s Advice Can Save Investors From Costly Mistakes was originally published by The Motley Fool

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