This Table Explains Exactly Why Warren Buffett and Berkshire Hathaway Have Struggled to Find Stocks to Buy and Where You Can Find Great Value Stocks Right Now

Greg Abel finally broke a 14-quarter streak for Berkshire Hathaway (NYSE: BRKA) (NYSE: BRKB) last quarter, when he purchased more stocks for the company's marketable equity portfolio than he sold. Before Abel took over as CEO, Warren Buffett spent the last three years trimming and selling off huge positions in Berkshire's portfolio, ultimately leaving Abel with a record $369 billion in cash available to deploy.

There's a good reason Buffett struggled to find good investments. There just wasn't a lot of value in the market available to him. Even today, Abel struggles to find ways to deploy a significant portion of Berkshire's cash. While he's made a splash by adding tens of billions to the Alphabet position Buffett initiated last year, other investments have remained relatively small.

A single table explains exactly why Berkshire has struggled to find attractive opportunities in today's market, but it also highlights the opportunity for investors like you and me to find great value.

Image source: Getty Images.

This table explains exactly where to find value in today's market

The following table shows the P/E ratio of various segments of the market relative to their 20-year historic P/E ratios.

Data source: J.P.Morgan Asset Management.

The table above shows that large-cap stocks trade at an average premium of 10% to 19% relative to their historical valuations. Value stocks have become the most overvalued relative to their historic trading range. That's a problem for a value investor like Buffett, Abel, or Berkshire Hathaway's other investment manager, Ted Weschler. Large-cap stocks are practically the only way for Berkshire to deploy significant capital. And if the average stock is trading above its historic average, there aren't going to be very many stocks trading at an attractive value.

Buffett summed up the problem in a single sentence in his 2023 letter to shareholders. "There remain only a handful of companies in this country capable of truly moving the needle at Berkshire, and they have been endlessly picked over by us and by others." Not only is Berkshire's investable universe small, but it's also well-followed, which makes it less likely that Berkshire will discover anything the market has overlooked.

But if you look further down the table on the left side, you'll find that small- and mid-cap value stocks are trading below their historic valuations. That's exactly where you should be looking for attractive value stocks. Large institutional investors are effectively unable to invest in smaller stocks because it's simply not worth the time to analyze a company just to invest a few million dollars for them when they're managing billions. But small retail investors can probably invest as much as they want in any publicly traded stock.

How to find great value stocks

Focusing on the portion of the market that much larger institutional investors often ignore can help find more mispriced companies and better values.

Investors can easily screen for businesses with consistent profits, growing free cash flow, and manageable debt levels trading at an attractive valuation. Take the top names and do your due diligence to determine whether a company has a durable competitive moat and if there's a reason the market is offering a discount on the stock.

If you don't understand exactly how a business makes money, there's no shame in putting it in the "too hard" pile. As Buffett said, "Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn't count."

Investors who don't want to do the homework can buy an ETF that invests in the attractive market segment. For those focused exclusively on small-cap value stocks, the Avantis US Small Cap Value ETF (NYSEMKT: AVUV) is a favorite. It doesn't just filter by valuation; it also uses profitability metrics and book value as additional checks to weed out value traps.

The Dimensional US Targeted Value ETF (NYSEMKT: DFAT) includes both small- and mid-cap value stocks. It also avoids companies with poor profitability to keep value traps out of the portfolio. As an actively managed ETF, it also empowers its traders to substitute stocks within its investable universe for one another to reduce transaction costs and potential tax consequences.

Either is a great option for investors looking to add exposure to the historically undervalued portion of the market, where big investors like Berkshire Hathaway don't spend much time.

JPMorgan Chase is an advertising partner of Motley Fool Money. Adam Levy has positions in Alphabet and American Century ETF Trust-Avantis U.s. Small Cap Value ETF. The Motley Fool has positions in and recommends Alphabet, Berkshire Hathaway, and JPMorgan Chase. The Motley Fool has a disclosure policy.