In recent years, the American stock market has experienced a notable uptrend, primarily fueled by companies with substantial cash reserves engaging in stock buybacks and cancellationsHowever, there is another parallel phenomenon worth examining: an increasing number of executives are selling off their company stocks in considerable quantitiesThis dual dynamic prompts a key question—while the existence of a bubble in the US stock market seems probable, discerning the extent of that bubble remains a complex taskOne useful approach may be to evaluate representative companies, allowing for “fuzzy yet correct” assessments.

For value investors, determining whether the stock market of a country has reached bubble territory or is languishing at an attractive low price is not overly difficult

Warren Buffett often employs a particular criterion for judgment; he likens it to recognizing a person who weighs 200 pounds: it is evident that they are overweightThis heuristic applies effectively to individual stocks, but discerning the valuation of an entire market presents challengesOne must consider which indicators can reliably signify whether the stock market is substantially overvalued or undervalued.

To address this, Buffett provides a broader standard: when the total market capitalization of the stock market over the GDP lands between 80% and 120%, equity valuations can generally be seen as normalIf it exceeds 120%, there may be concerns regarding overvaluation, although certainty cannot be establishedThis ambiguity arises because societal conditions change rapidly: two to three decades ago, traditional manufacturing dominated the economic landscape

Today, the astonishing profits of high-tech firms mark a significant shift in the economic structure.

Many analysts draw unfavorable comparisons between the current surge in the US stock market and the internet bubble of 2000. However, this perspective is flawedDuring the previous boom, internet companies operated under wildly optimistic price-to-earnings ratiosNowadays, the so-called “Big Seven” companies in the stock market not only consistently report earnings growth, but market expectations for their profitability remain robust as wellCurrently, there is scant evidence to suggest factors that would induce stagnation or decline in their profits.

Though it is clear that the American market is currently overvalued, the implications of this overvaluation remain somewhat nebulous

The landscape of capitalism may have evolved unnoticedFor instance, the scale of payment platforms today is unprecedented; PayPal and WeChat are prime examplesIt’s intriguing to ponder Buffett’s perspective on China, where payment systems are dominated by these platforms, especially in light of his substantial holdings in American Express.

Artificial Intelligence (AI) is poised to automate numerous jobs in the near future, inherently improving productivity and profitability, which should be reflected in market capitalizationsAs such, the future stock market may vary greatly from a few decades ago when traditional sectors predominantly fueled market activityThis shift might render some conventional metrics obsolete.

Nevertheless, the valuation of individual stocks remains a pertinent consideration: it is intrinsically linked to future cash flow projections

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Thus, scrutinizing specific equities can provide insights into whether the US stock market is overvalued and to what degree such overvaluation exists.

Take Dell Technologies for exampleWhen it released its fourth-quarter and annual earnings for fiscal year 2024, the stock surged more than 30%. The rationale behind this significant jump lay in a reported net profit increase of 25%. Despite this notable rise for a well-established hardware corporation, it is not particularly impressive against market expectationsConsidering the revenue reports, one might expect the stock price to plunge—indeed, Dell reported fourth-quarter revenues of $22.3 billion, down 11% year-on-year, with total revenues for the year falling 14% to $88.4 billion.

The company forecasted revenues of $91 billion for the upcoming fiscal year, falling short of market expectations of $92.1 billion

Analyzing Dell's income and profitability trends over the past few years suggests that business growth has stagnated, coupled with a trend of declining profit marginsWhile the COVID-19 pandemic contributed to these challenges, a downturn in the PC sector is widely recognized, and the gradual erosion of gross profit margin seems inevitable.

Even with such a traditional computer hardware entity, after hitting a low of $12 in March 2020, Dell’s share price climbed dramatically, peaking at $131 in a mere four-year span, reflecting a price-to-earnings ratio of around 25. Why might the market exhibit such enthusiasm? The answer likely stems from projections surrounding Dell's potential in AI serversAs the stock price has surged, company executives have significantly offloaded their shares, yet the market seems unfazedThis behavior vividly illustrates the current fervor surrounding AI.

Conversely, Costco's stock fell 7% following the release of its fiscal year 2024 second quarter results, attributed to slightly below-expected holiday sales

In reality, Costco's revenue continues to grow at a steady paceHowever, due to its larger size and elevated baseline, achieving prior high growth rates becomes increasingly challenging, although net profit growth remains commendable.

Upon examining Costco's stock performance, it becomes apparent that its recent decline may stem from having ascended too high too quickly: starting from $451 in March 2023 and spiking to $738 within a yearSince going public, Costco’s much-lauded business model has typically traded in the 20-30 times earnings multiple range—an extraordinarily high valuation for a retail companyYet, as the market has heated up, Costco has seen its valuation soar to nearly 50 times earnings.

Currently, Costco faces challenges associated with potential shifts in the retail landscape, especially against emerging cross-border e-commerce players like Pinduoduo's Temu and TikTok Shop

While Costco's unique model may afford it protection, it is likely that competitors such as Target and Walmart will feel the impact sooner.

Walmart's stock performance might suggest it has transformed from a unicorn to a dragon; however, it has only seen a 30% growth in operating revenue over the past decade, and its net profit has stagnatedPresently, Walmart trades at over 30 times earnings—valuations typically reserved for periods of rapid growth long past.

Realistically, it would be entirely reasonable for Walmart's earnings multiple to settle around 10, given its maturity and the potential for revenue contractionSimilarly, Target's valuation should logically align with 10 times earnings or lessWhile its latest profits for fiscal year 2024 reached $4.1 billion, significantly up from $2.8 billion the previous year, this figure remains far below its peak of $6.9 billion

This profit growth has largely been driven by cost reductions and increased efficiency.

Turning to the market's focus, the “Big Seven” have increased their combined market valuation by over 80% since January 2023, now comprising over 25% of the total market cap for the S&P 500 index, reflecting the highest degree of market concentration in nearly a decadeThe reason behind this is simple—AI generates formidable expectations for profitabilityAs some companies demonstrate exceptional earnings potential, investors shift focus away from those with slowing growth towards those expected to yield better future earnings.

In this context, companies like Apple and Tesla, which have lagged in their AI integration, have struggled to keep pace compared to the other five companies and have notably underperformed relative to the S&P 500 index in recent times.

For instance, Apple’s recent underperformance can be attributed to the fact that while this iPhone manufacturer has undertaken significant initiatives in AI, it has yet to clearly articulate plans for leveraging these advancements to both investors and consumers

Presently, only vague hopes exist that devices equipped with Apple GPT will entice consumers toward pricier, high-end smartphones.

But is it truly as simple as that? With a business model considered elite and unique, Apple should be generating more substantial value through AIHence, its failure to keep traction with index-driven growth isn’t surprising.

Despite being perceived as overvalued, Apple’s stock holds reasonable potentialShould it experience a pullback, opportunity could arise; its capacity for earning high profits remains fundamentally unchangedWith a price-to-earnings ratio currently around 27, a dip to 20 would enhance its attractivenessThus, from this perspective, Apple’s current valuation doesn’t substantiate claims of a bubble—it merely reflects typical market fluctuations.

The timing of any potential bubble burst remains elusive and challenging to predict.

What is Warren Buffett's take on the prevailing equity valuations in the US market? In his most recent letter to shareholders, he expresses a somewhat cryptic perspective

Buffett asserts that Berkshire has the capacity to mobilize significant capital to navigate market turbulence, presenting substantial opportunitiesHe emphasizes how the current stock market is far larger than when Berkshire originally started operatingHowever, he notes a concerning trend: today’s market participants, in terms of emotional stability and education, do not seem substantially more competent than those from his educational yearsAlarmingly, the market exhibits behavior analogous to that of a casino, with this phenomenon permeating family dynamics, constantly tempting household members.

Assessing whether the stock market is hemmed within a bubble and to what extent remains an intricate undertakingA hallmark of market bubbles is that as they near their inevitable collapse, their prices often surge—a curious phenomenon

It appears that to face destruction, manic exuberance must first flourishSuch dynamics are perennial nightmares for short-sellers, often leaving forecasters with egg on their faces.

Buffett often appears perplexed when discussing the marketHis increasing cash reserves and investments in short-term Treasury bills, as opposed to equities, confirm his cautious stance.

Over the past decade, many US stock companies have amassed considerable cash reserves, employing strategies reminiscent of Apple’s management—namely, using surplus capital for stock buybacks followed by cancellationsSuch enormous repurchase initiatives represent one of the catalysts driving share prices higher; stock cancellations further decrease liquidity, contributing significantly to price appreciation in recent years.

However, another contrasting trend has also emerged: a growing number of executives have begun liquidating substantial portions of their company stocks.

Regardless of this duality, it is evident that the American stock market is in a bubble; however, determining the precise extent of this bubble is a far more complicated conundrum