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.
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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