The S&P 500 has soared in the double digits over the past two years as investors have piled into growth stocks and bet on their successes in a lower interest rate environment. Growth companies generally outperform when they can more easily borrow to develop and expand, and a stronger economic backdrop means consumers have more money to spend on these players' products and services.
So, in a bull market, there's reason to buy and hold growth stocks. The gains over the past two years have been fantastic, but they've also resulted in something that isn't so great: higher valuations.
Stocks have become much more expensive than just a few years ago, reaching record levels. That may prompt you to wonder whether you really should buy stocks today. To help answer the question, let's turn to one of our favorite market experts, billionaire Warren Buffett, and check out what he's doing.
Investors often look to Buffett because he's demonstrated a strong understanding of the stock market over the long term. And this has resulted in market-beating returns. As chairman, he's helped Berkshire Hathaway deliver a compounded annual increase of nearly 20% over 59 years, compared to a 10% gain for the S&P 500. This is thanks to Buffett's strategy of investing only in industries and companies he understands, holding on for the long term, and always getting in on stock at a reasonable price.
Buffett may be the world's most well-known value investor -- an investor who buys a stock when it's trading below its intrinsic value, with the idea that the rest of the market will eventually recognize the company's strengths and hop on board. And that will push the stock higher, delivering gains to those who got it for a good price.
Speaking of value, this brings me to the market's current situation. The S&P 500, as mentioned, climbed over the past two years, even through the early weeks of this year, though the index has slipped since mid-February. Investors have been concerned about uncertainties, such as consumer spending and the impact of President Trump's tariffs on imports from countries like China and Mexico.
Meanwhile, as stocks have advanced, so have valuations. A great measure to consider is the S&P 500 Shiller CAPE (cyclically adjusted price-to-earnings) ratio because it considers stock prices and earnings over a 10-year period to account for economic fluctuations. Today, this measure has done something it's done only two other times since the S&P 500 launched as a 500-company index back in the late 1950s: It's surpassed the level of 37, suggesting that stocks are particularly expensive right now.
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Now, let's consider how Buffett is handling the situation. Last year, this top investor wasn't a buyer of stocks but rather a net seller. His net sales totaled $134 billion and included the sales of some of his biggest holdings, such as Apple and Bank of America, in which he reduced his holding by 67% and 34%, respectively.
This helped Berkshire Hathaway build up a record cash position of more than $334 billion. In his recent letter to shareholders, the billionaire wrote, "Often, nothing looks compelling; very infrequently we find ourselves knee-deep in opportunities."
Considering Buffett's recent moves, it's clear that he didn't find himself knee-deep in opportunities last year. And knowing the billionaire's interest in value, with the market trading at today's levels, he clearly hasn't been piling into stocks.
So, to follow in the footsteps of Buffett, should you avoid buying stocks right now? Not necessarily. Just because Buffett hasn't found opportunities galore doesn't mean he's stopped investing in stocks. He is still watching the market closely and buying selectively. For example, in the fourth quarter, he opened a new position in Constellation Brands (NYSE: STZ) and increased his position in Domino's Pizza (NASDAQ: DPZ) by more than 86%. Both companies are trading at lower valuations in relation to forward earnings estimates than they were a year ago.
This shows solid buying opportunities still exist right now, even if the market as a whole remains expensive. Of course, like Buffett, at times like today, you may not find yourself scooping up stocks like hotcakes due to the high valuations of many. But this doesn't mean you should stop investing and stay away from the market. If you did, you would miss out on investments that could pave your way to wealth.
Though Buffett is extra cautious at times, he's never abandoned stocks. Importantly, he wrote this in his recent shareholder letter: "Despite what some commentators currently view as an extraordinary cash position at Berkshire, the great majority of your money remains in equities. That preference won't change."
In any market environment, Buffett continues to look for stocks to buy and hold. This has been a winning strategy for him over time, and it could help the rest of us score a long-term victory, too.
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Bank of America is an advertising partner of Motley Fool Money. Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Bank of America, Berkshire Hathaway, and Domino's Pizza. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.
Should You Really Buy Stocks With the Market at Record-High Valuations? Here's What Warren Buffett Is Doing. was originally published by The Motley Fool
