There's a very good reason so many Wall Street and retail investors closely follow Warren Buffett's every word: He's exceptionally good at what he does.

While Buffett isn't infallible (surprising fact: none of us are), his track record speaks for itself. The Oracle of Omaha, as he's aptly been dubbed, has seen his net worth grow from around $10,000 in the mid-1950s to $90 billion as of today. What's more, the share-price appreciation of conglomerate Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), which Buffett has been CEO of for 50 years, has generated well over $400 billion in value for its shareholders.

Buffett is a master of creating wealth and finding deals, which is why investors have tended to ride his coattails to big gains and/or steady income over the years.

Berkshire Hathaway CEO Warren Buffett at his company's annual shareholder meeting.

Berkshire Hathaway CEO Warren Buffett at his company's annual shareholder meeting. Image source: The Motley Fool.

This Buffett quote on the stock market is an eye-opener

But what you might be surprised to learn is that not everything Buffett says is necessarily peaches and cream for investors.

For example, it's been more than 3 1/2 years since Berkshire Hathaway has made a needle-moving acquisition. By "needle-moving," I mean a buyout that will have a noticeable impact on the company's bottom line.

As a result, the company's cash balance has soared. At the end of September, Buffett's company was lugging around an all-time high $128.2 billion in cash, and Wall Street analysts were mystified as to why he wasn't spending it. After all, cash loses value to inflation over time, and Buffett has long believed in the stock market as the greatest long-term creator of wealth.

Why isn't Buffett putting his cash to work in stocks? Well, a quote from him in the company's 2019 annual shareholder letter pretty much says it all: 

In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects.

In other words, Buffett has no intention of abandoning his buy-and-hold ethos, but he's also not willing to bend on the idea that he wants a "wonderful company at a fair value." Right now, he simply doesn't view the market as attractively valued, and a number of metrics would appear to back up this assertion.

A magnifying glass held over the financial section of the newspaper, with the words, Market Data, enlarged.

Image source: Getty Images.

A very good argument that equities are not attractively valued

When Buffett released his annual letter to shareholders, it was Feb. 23, 2019. At that time, the benchmark S&P 500 (SNPINDEX:^GSPC) wasn't even at 2,800. This past Thursday, it closed at an all-time high of 3,317. As you can imagine, if Buffett didn't see value for brand-name businesses with the S&P 500 at 2,793 on the day he released his annual letter, he's certainly not going to be any more convinced of the value proposition with the S&P 500 rocketing another 19% higher in 11 months.

Another example of stretched valuations can be seen in the Shiller price-to-earnings ratio. The Shiller P/E ratio is based on average inflation-adjusted earnings from the previous 10 years. There have only been four times in history when the Shiller P/E ratio has climbed above 30: 

  • In 1929, just before the U.S. entered the Great Depression.
  • Between 1999 and 2000, just before the dot-com bubble burst.
  • In 2018, just before the stock market tumbled precipitously throughout the fourth quarter.
  • Right now, with the Shiller P/E a stone's throw from 32.

Although the stock market has consistently shown that corrections and bear markets will be erased by extended bull-market rallies, it doesn't mean that equities will move up in a straight line. Buffett realizes this, and has thus been holstering his company's cash in the hope of a significant retracement in equities.

Additionally, don't overlook the fact that we're in the midst of an earnings recession in the S&P 500. According to the latest Earnings Insight report from FactSet Research Systems, the S&P 500 is set for its fourth consecutive quarter of year-over-year earnings declines in Q4 2019. That hasn't happened in almost four years. Of course, the last time this happened, the S&P 500 underwent two corrections and the index remained relatively flat. Over the past year, the S&P 500 is up well over 30%.

A researcher in a white lab coat holding a vial of blood in his left hand, while reading from a clipboard in his right hand.

Image source: Getty Images.

Buffett may be at a disadvantage

Furthermore, Buffett's want to spend his cash may be limited by a number of factors.

For one, he has been clear that he's looking for a needle-moving transaction. Instead of picking up start-ups and small caps, he wants Berkshire to acquire businesses that'll have an immediate impact on the company's balance sheet. The problem is, large-cap valuations are pricier than small caps at the moment, despite the fact that small caps generally have higher growth rates.

A quick glance at data provided by market analytics company Yardeni Research shows that the S&P SmallCap 600 Index has a forward P/E of 17.8, compared with a forward P/E of 18.7 for the S&P 500 Large-Cap Index. This may not sound like a huge discrepancy, but it looks to be the highest forward P/E for large-cap stocks since 2002. Meanwhile, the current forward P/E for small-cap stocks is right around its average over the past seven years. In short, Buffett's focus on hitting a home run has him missing out on value in the small-cap space (companies valued between $300 million and $2 billion). 

What's more, Warren Buffett has always focused his attention on financials, consumer goods, and to some extent utilities. Not a strong believer in diversification (which is fine, as long as you know what you're doing), Buffett rarely makes moves beyond these sectors. That can prove to be a disadvantage when these sectors become pricey and other sectors or industries fly under the radar with reasonable valuations.

For instance, profitable biotechnology companies are valued near their lowest forward P/E ratios in history, dating back more than two decades. But since Buffett doesn't track healthcare companies, primarily because he doesn't have the time to devote to reading about clinical trials, he's missing out on potential values.

Eventually, Buffett is going to spend his cash hoard. But it clearly won't be on Wall Street's timeline.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.