Mathematically, the Buffett indicator is very simple. It is the market capitalization of a country divided by its gross domestic product. When the Omaha pundit proposed the ratio in an article in Fortune magazine, co-authored with journalist Carol Loomis, he considered it “perhaps the best single indicator of valuations at a given point in time.” He explained that if the ratio approached 200%, as it did in 1999 and 2000, “you are playing with fire. In other words, the market is overvalued. And when this indicator is above 70% or 80%, it is really profitable for investors to buy stocks. And this is exactly what this indicator is for: to know how the market is valued. Is it overvalued? Is it undervalued? Or is it undervalued? Overall, it is a good indicator to put the market in perspective when you need to determine if the market is expensive or not. However, it is not definitive as it only gives a general idea. Above Average. In February 2021, the Buffett indicator reached an all-time high of over 200%. Since then, the market has retreated and the indicator has declined. In mid-October, when annual U.S. GDP was $25.5 trillion and all markets were valued at $39.1 trillion, the U.S. ratio was 151%, according to the website Current Market Valuation. While still above the historical average, the stock market has fallen, bringing the market back into a more reasonable range of valuations. However, using this index in Canada is more difficult given that the Canadian market is more cyclical as it is a resource-rich country. This ratio is similar to the cyclicals because the Canadian market is a more resource-rich country. It is also very similar to the price-earnings ratio. This ratio can and should be considered in conjunction with the Buffett indicator. This is because the Nelson indicator, like all others, is not without its pitfalls. There are a few things to keep in mind. Warren Buffett was the first to admit it: his ratio is imperfect. The ratio has certain limitations. The first limitation is that the public market is not representative of all companies in the economy. The ratio takes into account only publicly traded companies. However, the ratio of public to private firms can change over time. And if there are more publicly traded companies, the ratio will be higher. But this does not necessarily mean that the market is overvalued, or at least undervalued. The second caveat is that the ratio ignores the profitability of the company. What gives a company “Nelson” value is the fact that it generates profits. Therefore, the first thing to consider in the analysis is profitability. Therefore, if we are trying to determine whether the market is overvalued or not, we would look at the price/earnings ratio of the market as a whole. Of course, one should not make major investment decisions based on such ratios. After all, even if the overall market is overvalued, it does not mean that there are no interesting companies in your portfolio. The third caveat is no less important. Companies are becoming more internationalized these days; this was true back in 2001, and it is even more so now. For example, a company may have a warehouse in Europe. However, this economic activity is not counted in the U.S. GDP, but the value of the company reflects it. This is another discrepancy that we need to be aware of. The bottom line is that even if an indicator is not bad overall, its use should be used sparingly, especially in combination with many other indicators.