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At the end of 2025, Warren Buffett stood down as the chief executive of Berkshire Hathaway. But with shares in the company worth over $100bn, I‘m sure he still takes an active interest in the stock market. And like many of us, I suspect he’s wondering whether a crash could be coming soon. Fortunately, over 20 years ago, the American billionaire investor came up with a quick way of assessing stock market valuations.
Let’s see what the ‘Buffett Indicator’ is currently telling us.
How does it work?
According to Buffett, comparing the total market-cap of a particular stock market to that country’s Gross Domestic Product (GDP) — expressed as a percentage — is “probably the best single measure of where valuations stand at any given moment”.
Currently (6 February), the indicator for the US market is showing 218%. This is close to its all-time high set in January, and well above the 20-year average of 127%. Could this be a sign of impending doom? Probably. But we don’t need Buffett’s indicator to tell us that stock market corrections, or worse, are regular occurrences.
Indeed, the tool is often criticised because GDP is a domestic measure whereas most companies have overseas earnings. And those who followed it in 2013 and 2020 — and decided to exit the US market — would have missed out on subsequent rallies.
On this basis, I reckon it’s a useful guide to stock market valuations but not one to be followed without question.
What about here?
Closer to home, it suggests prices aren’t quite as stretched.
The UK indicator’s reading 117%, which is bang in line with the average over the past two decades. However, it’s been sharply rising since early 2025. Despite this, it’s comfortably below the record high of 139% set in 2018.
But this is small comfort because if the US market crashes, something similar’s likely to happen here.
In some respects, Rolls-Royce Holdings (LSE:RR.) is a good example of what’s happening in the market — its share price is becoming increasingly disconnected from its underlying earnings. This is a sign of confidence but also a potential warning.
| Year | Forecast earnings per share (pence) | Price-to-earnings ratio |
|---|---|---|
| 2024 | 20.3 (actual) | 60 |
| 2025 | 24.8 | 49 |
| 2026 | 29.5 | 41 |
| 2027 | 33.3 | 37 |
| 2028 | 37.6 | 32 |
A series of profit upgrades and a strong post-pandemic recovery have helped its share price go on an amazing rally since the start of 2023. And as with the stock market in general, this has resulted in some people questioning whether a crash, or at least a correction, might be coming.
But I think it’s important to take a long-term view when it comes to investing. Although there will be some lumps and bumps along the way, a quality company will continue to out-perform over an extended period.
At the moment, Rolls-Royce has a healthy order book and the early signs are that its small modular reactor programme is going to be highly lucrative. Looking further ahead, if it does follow through with its plans to return to the narrowbody aircraft engine market, this could be transformational.
Yes, the group’s shares are expensive and its dividend is mean. But this doesn’t really matter if it can continue to improve its earnings in line with forecast. However, any sign of a slowdown and I’m sure the share price will suffer.
Despite this, because of its excellent reputation and the long-term opportunities it’s exploring, I still reckon Rolls-Royce is a stock to consider.
