What is Buffet Indicator
Legendary investor Warren Buffet use the ratio of Market Capitalisation to GDP to gauge the reasonability of valuation of the stocks.
Buffet Indicator= Market Capitalisation/GDP
Market Capitalisation= Share market price of a Share* Number of Shares
This ratio is derived by using the total market capitalisation of a country's listed stocks as the Numerator and GDP as the denominator. It is probably the best measure of where valuations stand at any given moment.
At present, after massive surge in pricing of Mid-Cap and Small Cap, this indicator is all time high for Mid-Cap and Small-Cap indicating that market capitalisation exceeds the Economic Growth. (Like for Small Cap it was 11% in Jan-21 which has now become 24% in December 2023, For Mid-Cap it has increased from 15% in Jan-21 to 20% in December-2023)
Problem with Small and Mid-Cap is that they are appears to be more volatile than large caps. That along with frothy valuations warrants increased caution.
Given the high mortality rate that Small Caps have i.e. only 10% of Small Cap become Mid-Cap over five-ten years period, the rest remains small Cap or becomes micro-caps.