Warren Buffett makes investment decisions based on business fundamentals rather than the broader market environment.
The S&P 500 (^GSPC 0.49%) has advanced 12% year to date, notching 25 record highs in the process. What makes that number particularly extraordinary is the index was actually down 19% from its high in April when President Trump announced tariffs. But it quickly rebounded and has since rocketed 32% from its April low.
That upward momentum begs the question: Should you really buy stocks with the S&P 500 racing through record highs? Warren Buffett has pertinent advice, and historical data provides a clear answer to that question.
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Warren Buffett’s sensible advice on picking stocks
Warren Buffett owns about 198,000 shares of Berkshire Hathaway Class A stock, which has returned nearly 6,000,000% since he took control of the company in 1965. That puts his net worth at roughly $150 billion. And he earned that fortune by adhering rigorously to his patient, value-oriented investment strategy.
Buffett has never shied away from stocks because the market was at record highs, nor has he chased stocks simply because the market was moving higher. Instead, he has focused on buying competitively advantaged businesses at reasonable prices without regard for the broader market environment. He explained his strategy in his 1996 shareholder letter:
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, ten, and twenty years from now. Over time, you will find only a few companies that meet these standards — so when you see one that qualifies, you should buy a meaningful amount of stock.”
There is gray area in that advice. The definition of “rational price” is open to interpretation. But a good rule of thumb is to look for stocks trading at or below their average valuation in recent years, provided the valuation itself is not absurd. For instance, Apple‘s price-to-earnings (PE) ratio has ranged from 9 to 50 in the last 20 years, with an average of 23. Keep that in mind as you consider this timeline:
- Q1 2016: Berkshire starts purchasing Apple. Shares trade at 11 times earnings.
- Q4 2017: Berkshire makes Apple its largest holding. Shares trade at 18 times earnings.
- Q4 2023: Berkshire starts selling Apple. Shares trade at 30 times earnings.
- Q4 2024: Berkshire sells half its remaining stake in Apple. Shares trade at 39 times earnings.
- Q2 2025: Berkshire continues to sell Apple. Shares trade at 31 times earnings.
The market can be irrational for long periods of time, but valuation always matters eventually. Buffett writes, “For the investor, a too-high purchase price for the stock on an excellent company can undo the effects of a subsequent decade of favorable business developments.” That means there is no such thing as a stock worth buying at any price.
The stock market has historically performed well from record highs
Investors may be surprised to learn the stock market has typically performed very well after reaching a record high. The following chart compares the S&P 500’s forward returns (excluding dividends) from record highs versus its forward returns from all other days. The data was collected between 1970 and 2024.
|
Holding Period |
S&P Return (Invest at Record High) |
S&P 500 Return (Invest at Any Other Time) |
|---|---|---|
|
3 months |
1.5% |
2.2% |
|
6 months |
4.3% |
4.4% |
|
12 months |
9.4% |
9% |
|
24 months |
20.2% |
18.4% |
Data source: JPMorgan Chase. Data collected between 1970 and 2024.
As shown above, the S&P 500 has achieved an average return of 9.4% during the 12-month period following record highs. That is slightly better than its average return of 9% during the 12-month period following non-record highs, according to JPMorgan Chase. Likewise, the index has also performed better during the 24-month period following record highs as compared to the 24-month period following non-record highs.
As a caveat, the S&P 500 currently trades at 22.5 times forward earnings, a premium to the 10-year average of 18.5 times forward earnings. That is a very expensive valuation, and it has frequently correlated with negative returns in the next year. Based on that multiple, we can deduce that many stocks in the S&P 500 trade at rich valuations, which means sensible buying opportunities are limited in the current market environment.
JPMorgan Chase is an advertising partner of Motley Fool Money. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Berkshire Hathaway, and JPMorgan Chase. The Motley Fool has a disclosure policy.