Usually Warren Buffet says sensible things about the stock market, so I try to understand it. The Warren Buffet indicator is the ratio between the total us stock market value and GDP. If the ratio is high market is overvalued and vice versa. I don't deny that this indicator has some meaning, but I just can't wrap my head around it. I am aware warren doesn't blindly support it.
The way that I understand it GDP is the total of all transactions. If I would translate it to the stock market you could roughly say it is all the revenue generated. However, there are probably transactions that don't count as revenue in the stock market, like a gift to a non-profit. And there are private companies.
But let's say this holds, then somehow companies should be valued 1:1 by revenue on average. However, that is not how I understand it. Any piece of revenue can come with profit. The percentage profit of revenue is not necessarily stable over time, depends on great many factors. Furthermore, each piece of profit is not necessarily valued the stabily. This also depends on a great many factors.
In my head, the buffet indicator could hit 0.1 or 10 without any fundamental over/undervaluation. So what does GDP have to do with total stock market value, how is it related, and why should it average at 1 long term? Does average net margin x average pe ratio trend to average revenue? Historically I don't see it deviating to much in the example graphs, indicating there might be some meaningfull connection.
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