The stock market capitalization-to-GDP ratio is a ratio used to determine whether an overall market is undervalued or overvalued compared to a historical average. The ratio can be used to focus on specific markets, such as the U.S. market, or it can be applied to the global market, depending on what values are used in the calculation. It is calculated by dividing the stock market cap by gross domestic product (GDP). The stock market capitalization-to-GDP ratio is also known as the Buffett Indicator—after investor Warren Buffett, who popularized its use. It is a measure of the total value of all publicly traded stocks in a market divided by that economy's gross domestic product (GDP).

1. It indicates that investors are willing to pay 20 times the average earnings over the past decade, adjusted for inflation.
2. The World Bank releases data on the Stock Market Capitalization to GDP for World which was 92% in 2018.
3. The stock market capitalization-to-GDP ratio is also known as the Buffett Indicator—after investor Warren Buffett, who popularized its use.
4. India has potential, but its current valuations suggest risk outweighs reward.
5. GDP growth in the second quarter of fiscal 2018 rose to 6.3 percent from 5.7 percent in the first quarter.

In recent years, however, determining what percentage level is accurate in showing undervaluation and overvaluation has been hotly debated, given that the ratio has been trending higher over a long period of time. Typically, a result that is greater than 100% is said to show that the market is overvalued, while a value of around 50%, which is near the historical average for the U.S. market, is said to show undervaluation. If the valuation ratio falls between 50% and 75%, the market can be said to be modestly undervalued.

Statistics

1. It is calculated by dividing the stock market cap by gross domestic product (GDP).
2. Industry-specific and extensively researched technical data (partially from exclusive partnerships).
3. Still, data from Bloomberg shows that the market cap to GDP ratio is above 100 percent for the first time since 2007.
4. However, in 2003, the ratio was around 130%, which was still overvalued, but the market went on to produce all-time highs over the next few years.
5. Until these indicators point to a more balanced market, Buffett is likely to remain on the sidelines.

The use of the stock market capitalization-to-GDP ratio increased in prominence after Warren Buffett once commented that it was "probably the best single measure of where valuations stand at any given moment." This indicates that the Indian stock market has outpaced economic growth. A high Buffett Indicator may mean that stocks are overpriced compared to the GDP they rest on, potentially setting investors up for losses if the economy can't support these inflated values. market cap to gdp ratio india GDP growth in the second quarter of fiscal 2018 rose to 6.3 percent from 5.7 percent in the first quarter.

Formula and Calculation of the Stock Market Capitalization-to-GDP Ratio

A reading above 100% suggests an overvalued market, while a lower reading indicates potential undervaluation. The market cap to the global GDP ratio can also be calculated instead of the ratio for a specific market. The World Bank releases data on the Stock Market Capitalization to GDP for World which was 92% in 2018. For a conservative, value-focused investor like Buffett, the Indian market’s inflated indicators are a turnoff. These signals don’t align with his investment philosophy, which focuses on intrinsic value and steady growth.

Market cap of listed domestic companies as share of GDP India 2005-2022

Some argue that listed enterprises in India may represent a smaller subset of industries where growth is higher than in the broader economy. To calculate the total value of all publicly traded stocks in the U.S., most analysts use The Wilshire 5000 Total Market Index, which is an index that represents the value of all stocks in the U.S. markets. The quarterly GDP is used as the denominator in the ratio calculation. This simple ratio gauges whether a market is overvalued or undervalued by comparing the total value of all publicly traded stocks in a country to the country’s GDP.

Market capitalization of listed domestic companies as share of gross domestic product in India from 2005 to 2022

The ratio compares the value of all stocks at an aggregate level to the value of the country's total output. The result of this calculation is the percentage of GDP that represents stock market value. The market cap to GDP ratio is a reflection of the valuation of listed enterprises vis-a-vis the value of goods and services produced in an economy. In theory, equity valuations should be linked to earnings expectations, which in turn are linked to the underlying economy. The indicator was popularised by the likes of Warren Buffet, who cited it as a key metric he watches. However, not everyone believes that the indicator is relevant to India.

Still, data from Bloomberg shows that the market cap to GDP ratio is above 100 percent for the first time since 2007. The indicator is not strictly comparable over time since the set of listed companies continues to change as new firms enter the market and some exit. As benchmark equity indices move from one record high to the next, indicators that reflect the value of listed firms vis-a-vis fundamental of the economy are flashing red.

India’s Buffett Indicator: A Warning Sign?

For the full year, the government’s statistical office has estimated growth at 6.5 percent. Indian equity markets have mostly ignored signs of economic sluggishness and surged due to strong inflows of domestic and overseas capital. Also, the market may be fair valued if the ratio falls between 75% and 90%, and modestly overvalued if it falls within the range of 90% and 115%.

Until these indicators point to a more balanced market, Buffett is likely to remain on the sidelines. In 2000, according to statistics at The World Bank, the market cap to GDP ratio for the U.S. was 153%, again a sign of an overvalued market. With the U.S. market falling sharply after the dotcom bubble burst, this ratio may have some predictive value in signaling peaks in the market.

As a stock analyst, it will be interesting to see the difference in values between the P/E and CAPE ratios.