Warren Buffett sits on the throne as one of the most successful investors of all time. The "Oracle of Omaha" has consistently outperformed the market for over 50 years on average.
One little-known valuation tool used by Buffett himself suggests a rare buying opportunity for Aussie investors.
This measure, which has helped the billionaire investor capture market trends for many years, is now signalling that ASX shares might be undervalued.
Let's take a look.
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What the Warren Buffett Indicator tells us
Warren Buffett has a variety of tools he uses to identify great investments before the average investor. What's more, he claims to have never used a spreadsheet.
You may or may not have heard of the Buffett Indicator. It compares the total market capitalisation of all companies on a country's stock exchange to the country's gross domestic product (GDP). Every listed business feeds into the number, whether it underwrites mortgages, runs the best online casino on the market, or ships bulk commodities. The smaller the percentage, the more undervalued the shares might be.
Warren Buffett's thinking is that because one measures the value of the market and one measures the value of the economy, if the ratio is out of synch, it could suggest the market is over or undervalued.
In Australia, the ASX All Ordinaries Index (ASX: XAO) has a total market cap of $2.6 trillion at the time of writing.
This compares to the nation's GDP of $1.79 trillion USD (approximately $2.7 trillion AUD), according to the International Monetary Fund (IMF).
This puts the Buffett Indicator for Australia at around 96%, meaning the Aussie market could be undervalued when compared to the economy. Or, at least on par with value.
What about last year? According to my colleague Seb, in July last year, the indicator was showing an eye-watering 194.6%.
It was also more than 172% back in 2018, and then more than 136% in 2015, showing how the ratio has come down sharply in the last ten years.
In that case, this might be a once-in-a-decade opportunity. Time will tell.
Where are the opportunities?
Whilst it's a nifty tool, you should note that the Buffett Indicator isn't flawless, and it's no crystal ball. Even Warren Buffett himself will tell you that.
But when looking at the broader picture, this month's market volatility may have opened up an opportunity.
The current ratio suggests that the Australian stock market might be offering some attractive buys right now.
In my opinion, two standouts are Wesfarmers Ltd (ASX: WES) and Qantas Airways Ltd (ASX: QAN).
Wesfarmers has a diversified portfolio of low-cost brands that provide high returns on capital and moat-like advantages. This aligns with Warren Buffett's core investment tenets.
UBS projects the business to produce $2.5 billion of profit this year, which could grow by 19% per year until FY26.
The share is up 44% in the past year, currently priced at $72.85 apiece.
Meanwhile, Qantas shares are positioned to benefit from the ongoing recovery in air travel, according to top brokers.
After being heavily sold these past three months, the stock is trading at a price-earnings ratio (P/E) of 6.54 times, making it too cheap for me to ignore right now. Warren Buffett would be proud.
UBS and Morgans rate the stock a buy with price targets of $6 and $7, respectively, whereas Goldman Sachs' rating comes with a $8.05 target. This suggests an upside potential of 34% at the time of writing.
All brokers expect large profits from the airline, with Goldman baking in $2 billion in FY24 profits to its forecasts.
Morgans also projects the flying kangaroo to buy back stock if profits fall within the broker's projections.
Foolish takeaway
The ASX has been facing some turbulence recently, with rising interest rates and global economic uncertainty impacting share prices.
However, these challenges have also created opportunities. If the Buffett Indicator is correct, now might be a great time for savvy investors to consider adding quality ASX stocks to their portfolios.
Warren Buffett's valuation tool is indicating that ASX shares could be undervalued, presenting a once-in-a-decade chance to get rich.
In my view, Wesfarmers and Qantas are just two examples of companies that might be trading at attractive prices right now.
