Monday, February 09, 2009

Buffett's and Shiller's stock valuation methods agree

Carol Loomis of Fortune has a new article out saying that Warren Buffett's valuation metric says it's time to buy stocks. I decided to compare Warren Buffett's stock valuation metric with Robert Shiller's. They both compare nicely.

Warren Buffett's stock valuation metric: Total stock market value as a percent of GNP.

Yale economist Robert Shiller's stock valuation metric, based on Benjamin Graham's advice in Security Analysis: S&P 500 10-year price/earnings ratios.

Robert Shiller doesn't compare the S&P 500 only to its current year earnings. Instead, he compares it to the average of the past ten years, adjusted for inflation. This way, he avoids getting fooled when single-year corporate earnings rise and fall with the business cycle.

Although Warren Buffett's and Robert Shiller's valuation methods are entirely different, they both seem to track each other fairly nicely. Knowing what happened in 1929, however, it looks like Robert Shiller's valuation method is slightly better than Warren Buffett's.


  1. Buffets is more of a rule of thumb; whereas Schiller has a much more scientific approach (which I would expect from a leading economist).

    Besides, the decrease in GNP for the Great Depression has no modern equivalent.

    Very nice comparison.


  2. I just started dollar-cost-averaging back into the S&P 500 index. I've got a total of $350K to put back into the market.

  3. I remembered reading about DCA and thinking the premise was illogical, so I just did some research.

    From Wikipedia:
    Dollar cost averaging has been widely criticized by economists and academic finance researchers as more of a marketing gimmick than a sound investment strategy.[4] They say that DCA is a way to gradually ease worried investors into a market, investing more over time than they might otherwise be willing to do all at once. Analysis supporting dollar cost averaging has been criticized because it often ignores transaction fees, which can be substantial. Numerous studies of real market performance, models, and theoretical analysis of the strategy have shown that in addition to having the admitted lower overall returns, DCA does not even meaningfully reduce risk when compared to other strategies, even including a completely random investment strategy.

  4. Based upon your re-post of information derived from Wikipedia;

    I made one lump-sum purchase to get back into the market this afternoon.

    Thanks for enlightening me.

  5. "I remembered reading about DCA and thinking the premise was illogical, so I just did some research."

    I'd stay clear from wiki for investing research...IN terms of DCA being a marketing pitch, it depends on who you are investing with, if you are investing with a broker who charges commissions, DCA might not be worth is since you will get charged transaction fees, if you are investing in index funds (say vanguard) with no transaction fees or commissions, it may be a better approach (although in the end, in the end it really depends on how the market behaves during the ramp up period). If you have continued volatility, DCA may add value depending on the purchase date. For example, say you were rebalancing to your equity target at the end of October have the big selloff, had put all money in at the end of October, you would be worse off than had you contributed at the end of November, December and January.

  6. Kahner said Wikipedia said...
    "Analysis supporting dollar cost averaging has been criticized because it often ignores transaction fees, which can be substantial."

    This is ridiculous! Index funds don't charge transaction costs. If you're dumb enough to invest in mutual funds with front-end loads, there still shouldn't be a change in the load. The only time you'd have higher transaction costs are if you are buying ETFs or individual stocks, which are the wrong investments to buy using dollar cost averaging.

    I think I need to do some Wikipedia editing.

  7. Dollar cost averaging only works if the market during the time that you are investing goes equally above and below a flat or up-trending trendline.

    This has been relatively rare. The market trend has resulted in two large humps that spent a great deal of time above the ultimate trendline. We took a decade to go no where and spent much of that time well above trend. If say we went from DOW 8000, down to DOW 4000 and spent some time down there before coming back up to DOW 8000 again....then your returns would have been much better. Obviously going all in at DOW 8000 and then ten years later your at 8000 then you've had flat returns no matter what happened in the middle. If you spent more time above 8000 in between, the DCA is dumb. If you spent more time below, the DCA is genius.

    Anyone who is a long term investors and lements a falling stock market is clueless. Without the dip in 2003 (which at the time was considered bad) stock owners today would have been much worse off. That dip was the only reason I was able to recoup some returns and then thankfully sell it all in Feb of 2007.

    Anyone buying today has to ask why so soon? There will be plenty of time to get on board what will be a considerable slow uptrend that might not start for years. Don't worry you won't miss out on a pop back up to 14000 tomorrow. There is still alot of downside left, plenty of time to save up cash and move in later.

    Average Joe

  8. Nouriel Roubini says there is another 2.6 trillion in writeoffs coming. Doesn't sound like a bottom to me.

  9. Suzi Ortman said on Good Morning America this morning... that the bail out needs to pay off the homeowner who paid too much for thier houses " thru no fault of thier own".

    Its not thier fault they paid too much for thier home! Its not thier fault they over bid! Its not thier fault they were getting into the game! Its not thier fault they have an 80/15/5!

    Dear Suzi, just whos fault is it?