Warren Buffett's Annual Letter Shares 4 of the Most Chilling Words Investors Will Ever Witness

When Berkshire Hathaway's (NYSE: BRK.A)(NYSE: BRK.B) billionaire chief speaks, Wall Street wisely listens. That's because Warren Buffett has vastly outperformed the benchmark S&P 500 (SNPINDEX: ^GSPC) in his 60 years as CEO. The aptly dubbed "Oracle of Omaha" has overseen a cumulative gain in Berkshire's Class A shares (BRK.A) of 6,076,172%, as of the closing bell on Feb. 24.

Picking Buffett's brain happens a number of ways. Quarterly filed Form 13Fs allow investors to see which stocks he and his top advisors, Todd Combs and Ted Weschler, have been buying and selling. Likewise, Berkshire's quarterly operating results provide insight on whether Buffett and his team are net buyers or sellers of stocks.

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Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.

But perhaps the most insight can be gained from the Oracle of Omaha's annual shareholder letter. These letters often cover the basics, such as how Berkshire Hathaway performed in the latest year, as well as dive into the psyche of what characteristics Buffett looks for in his investments.

Although these shareholder letters are typically known for their unwavering optimism, Buffett's newly released letter contains four of the most chilling words investors will ever witness.

The Oracle of Omaha just made a blunt assessment of stocks

To reiterate, Warren Buffett is, first and foremost, an optimist. On a number of occasions, he's cautioned investors not to bet against America, and has previously suggested that owning an S&P 500 index fund is one of the best ways to gain exposure to great American businesses.

Berkshire's chief takes this stance because he recognizes the nonlinearity of economic and stock market cycles. This is to say that Buffett realizes economic recessions and stock market corrections are both normal and inevitable. Rather than trying to time when they'll occur, Berkshire's brightest investment mind plays a simple numbers game.

Whereas recessions and bear markets are historically short-lived, periods of U.S. economic growth and bull markets last substantially longer. Statistically, it makes a lot more sense to be a long-term optimist.

Despite this unwavering optimism, the Oracle of Omaha is an exceptionally picky investor who wants a perceived value when he's building a stake in a publicly traded company.

When discussing how he and his team invest Berkshire's capital under the "Where Your Money Is" subhead from the company's latest shareholder letter, Buffett bluntly notes, "Often, nothing looks compelling." These four chilling words turn Buffett's proverbial cards face-up for investors and plainly show that he's struggling to find value in a historically pricey stock market.

"Often, nothing looks compelling"

Truth be told, we didn't need Berkshire Hathaway's annual shareholder letter to know that Warren Buffett isn't pleased with broader market equity valuations.

Over the previous nine quarters (Oct. 1, 2022 through Dec. 31, 2024), Berkshire's billionaire leader has been a net seller of stocks, to the tune of almost $173 billion on an aggregate basis. This includes $134 billion in selling in 2024 and the company's cash pile ballooning to north of $334 billion, including U.S. Treasuries.

In one respect, the overall stock market is at one of its priciest valuations in history. The "Buffett Indicator," which divides the total market cap of all publicly traded U.S. companies into U.S. gross domestic product (GDP), hit an all-time high on Feb. 18. Whereas the average reading for the Buffett Indicator has been 85% (i.e., the market cap of all stocks averages 85% of U.S. GDP) since 1970, it topped out at 207.46% on Feb. 18.

S&P 500 Shiller CAPE Ratio data by YCharts.

It's a similar story for the S&P 500's Shiller price-to-earnings (P/E) Ratio, which is also regularly referred to as the cyclically adjusted P/E Ratio (CAPE Ratio). This valuation tool is based on average inflation-adjusted earnings from the previous 10 years, and it's been back-tested to January 1871.

Over the last 154 years, the average Shiller P/E reading is 17.21. As of the closing bell on Feb. 24, the S&P 500's Shiller P/E Ratio chimed in at 37.73, which effectively marks its third-highest reading during a continuous bull market, dating back to 1871. Readings above 30 have historically foreshadowed pullbacks of at least 20% in the S&P 500.

On top of the stock market being pricey, some of Berkshire Hathaway's core holdings aren't the values they once were.

When top holding Apple (NASDAQ: AAPL) was added to Berkshire's portfolio in the first quarter of 2016, it traded at a P/E multiple in the low teens. As of Feb. 24, investors were paying more than 39 times trailing-12-month earnings to own this tech giant. Perhaps it's no surprise that Buffett oversaw the sale of roughly 615.6 million shares of Apple over a one-year period.

Image source: Getty Images.

Being patient has paid off handsomely for Buffett and Berkshire's shareholders

Considering how pricey Wall Street's major stock indexes are, and taking into account that Buffett has been a net seller of stocks for nine consecutive quarters, it's unlikely that he and his advisors will be deploying a significant portion of Berkshire Hathaway's treasure chest anytime soon.

However, Buffett's latest shareholder letter also offered words of encouragement and reinforced the long-term ethos that he and late right-hand man Charlie Munger infused at the company. Said Buffett,

"Berkshire shareholders can rest assured that we will forever deploy a substantial majority of their money in equities -- mostly American equities although many of these will have international operations of significance."

Put bluntly, Warren Buffett is looking for a good deal and wants a reason to put his company's capital to work. But he's a value investor at heart and isn't going to chase multinational businesses higher if the valuation doesn't warrant it.

Historically, the Oracle of Omaha's willingness to exercise patience and wait for valuations to come back to Earth has worked wonders, as the greater-than 6,000,000% cumulative gain in Berkshire's Class A stock over the last six decades proves. But when "nothing looks compelling," investors can expect selling activity to outpace purchases on a regular basis.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Berkshire Hathaway. The Motley Fool has a disclosure policy.