Opportunities outside of the top performers.
It’s no secret that a small number of stocks in the S&P 500 have been largely responsible for the index’s sizable return this year. The ongoing artificial intelligence boom has propelled a select group of companies into the spotlight, including energy provider Vistra, chipmaker Nvidia, and AI software leader Palantir Technologies.
Because the S&P 500 is market-cap weighted—meaning the shares with higher market caps have a larger impact on overall performance—such stocks account for a big chunk of the index’s 2024 return.
A significant valuation gap has emerged between the top-performing megacap stocks and the rest of the market, creating a potential opportunity for savvy investors willing to dig deeper. While the S&P 500’s price-to-earnings (PE) ratio sits at 26.9, the equal-weighted version of the index—which gives no preference to the largest stocks—has a much lower PE ratio of 20.9, as shown in the chart.
That spread of 6 percentage points is the widest in 10 years.
Source: Bloomberg, calculations by Horizon Investments, as of December 2, 2024. The price-to-earnings (P/E) ratio measures a company's current share price relative to its per-share earnings. Indices are unmanaged and do not have fees or expense charges, both of which would lower returns. It is not possible to invest directly in an index.
The implications for investors:
- Due to the AI frenzy, there may be plenty of undervalued names that investors are currently overlooking. In fact, the PE ratio of the average S&P 500 stock today is the same as it was in early 2017.
- With their relatively high valuations, today's “top” stocks may be more vulnerable to losses in the event of a downturn or unexpected bad news. However, elevated valuations alone don’t necessarily signal an impending pullback.
While we continue to look for ways to benefit from AI's growth, we also see opportunities to diversify via smaller-cap stocks and value-oriented shares that may offer strong return potential.
By Mike Dickson, Ph.D.
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The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. Reference to an index does not imply that any account will achieve returns, volatility, or other results similar to that index. The composition of an index may not reflect the manner in which a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility, or tracking error targets, all of which are subject to change. It is not possible to invest directly in an index. Information obtained from third-party sources is believed to be reliable but has not been vetted by the firm or its personnel.
This commentary is written by Horizon Investments’ asset management team. Past performance is not indicative of future results. Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security. This report does not attempt to examine all the facts and circumstances that may be relevant to any company, industry, or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Horizon Investments, LLC (“Horizon”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice, or recommendation in this document, clients should consider whether the security in question is suitable for their particular circumstances and, if necessary, seek professional advice. Investors may realize losses on any investments. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. All investing involves the risk of loss.
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