Warren Buffett’s Berkshire Hathaway has amassed a record $325 billion in cash. This is more than the combined cash reserves of Apple, Microsoft, Alphabet, Amazon, and NVIDIA, despite these tech giants having a collective market value 14 times larger than Berkshire’s. Buffett’s cash pile has doubled in just over a year.
Companies typically save cash for three main reasons: to weather an economic storm, to make a major purchase, or because they believe current market options are overvalued. A key indicator that could explain Buffett’s strategy is the S&P 500 index’s historic price-to-earnings (P/E) ratio. The market’s P/E ratio is currently 67% above its historical norm and almost 50% above its early 2022 value.
This suggests that stocks may be overvalued, a scenario in which Buffett prefers to hold onto cash.
Buffett’s cash strategy amid overvaluation
The chart for the S&P 500’s P/E ratio since 2022 shows that investors are now paying $30 for each dollar of earnings for the trailing 12 months.
This is a sharp increase from the historical median of 17.9. Stock prices may be driven more by investor optimism than by the underlying value of these stocks. Buffett’s investing principle is to be fearful when others are greedy. Given his commitment to “extreme fiscal conservatism” and the high market valuations, Berkshire sold over $100 billion in stocks during the first nine months of 2024, including reducing its substantial stake in Apple by two-thirds.
Buffett has emphasized that maintaining a sizable war chest is essential for Berkshire. The cash reserves proved invaluable during the 2008 financial crisis when Berkshire provided crucial funding to companies like Goldman Sachs and Bank of America on extremely favorable terms, generating substantial profits. Historical charts of the S&P 500 index P/E ratio suggest that high ratios often precede major market downturns, with notable examples including 1987, 1992, 2002, and 2008.
At the end of 2023, Buffett reassured shareholders that “Berkshire can handle financial disasters of a magnitude beyond any heretofore experienced.” While this should comfort his company’s investors, the necessity of such a reminder in the current market conditions is unsettling for everyone else.
