How to calculate Market Capitalization to GDP Ratio l How to know that market is undervalued or not?
Definition
The Buffett Indicator is also known as the “Market Capitalization to GDP Ratio”. This ratio helps to assess the entire stock market of a country, not only a single stock. It is similar to price-per-sales ratio, which is used to analyse a single company, but the Buffett Indicator is used to assess all listed companies in an entire country. It is used to learn that the overall market is overvalued or undervalued.
The Buffett Indicator (Market Capitalization to GDP Ratio)
There are two key ingredients needed to compute the Market Capitalization to GDP Ratio (Buffett Indicator)
1. Total of market capitalization of all listed companies of an entire country.
2. GDP (Gross Domestic Product) value of the country.
The following formula is used to compute the Buffett Indicator’s value:
Buffet Indicator (%) = (Total of market capitalisation of all listed companies X 100) ÷ GDP of that country.
The market is considered expensive and overvalued if the obtained value is above of 100%, and if the obtained value is below of 100%, the stock market is considered undervalued relative to country’s GDP.
Ans. The Buffett Indicator provides an insight of entire stock market relative to country’s GDP. If obtained value is greater than 100% then market is considered as expensive and overvalued. If value is below of 100% then market is considered undervalued and there may be a buying opportunity in the market.
Q. How to calculate the ratio?
Ans. To calculate the ratio, use the following formula –
Buffet Indicator (%) = (Total of market capitalisation of all listed companies X 100) ÷ GDP of that country.
Q. How often does the Buffett Indicator be checked?
Ans. Typically, this ratio is used the long-term investors periodically, to wit, annually, half yearly or quarterly rather than daily, weekly or monthly. It’s useful to measure the market in long-term.
