Value-focused investors may be a little concerned by the S&P 500’s strength over the past two years. The index level has surged from below 4,000 to around 6,000 over the past 24 months. This is an increase of approximately 50% in just two years.
Too hot for some investors
This rapid growth has led to high valuations and potentially unrealistic expectations for future earnings. The S&P 500 is currently trading at 23 times forward earnings, or around 20 times when excluding the Magnificent 7, which are considered expensive on an absolute basis. The Magnificent 7 are Apple, Microsoft, Alphabet (Google’s parent company), Amazon, Nvidia, Meta (formerly Facebook), and Tesla.
Of course, hot valuations can be justified by earnings growth, and S&P 500 earnings are expected to grow by more than 12% in 2025, driven by a strong US economy, artificial intelligence (AI), and possible tax cuts from the incoming US president.
Concentrated growth
In a remarkable display of market concentration, the Magnificent Seven stocks dominated the S&P 500’s performance in 2024. This elite group — — accounted for more than half of the index’s impressive 23% gain.
While most of these stocks appear expensive on face value, they’re forecasted to play an outsized role in our future. They dominate areas like AI, humanoid robotics, autonomous driving, and even intra-planetary life.
Head for the ‘smaller’ stocks
Several analysts and investors are saying the place to look for value is the mid-caps, as well as smaller companies. Mid-cap stocks are not typically traded on the S&P 500, but the term can be used fairly liberally here. The point is, with investors focused on the Mag 7 and JPMorgans of the world, smaller companies have been overlooked.
What’s more, these companies are more likely to benefit as interest rates fall, owing to debt repayments and credit needs. Across 13 rate cut cycles since 1973, the S&P 500 has seen positive annual returns after the first rate cut. That’s a good sign.
So, is there a chance to get rich with the S&P 500 this year? Well, given some of the rich valuations, investors may be able to generate outsized returns with some carefully picked stocks. It might not be immediate riches, but it could put an investor on the path to building long-term wealth.
One to consider
One stock worth considering is North American insurance provider Allstate (NYSE:ALL). A smaller member of the S&P 500, it presents a compelling investment opportunity, particularly for value-focused investors.
The insurer is performing well, with a 14.7% revenue increase to $16.6bn in Q3 2024 and a net income of $1.2bn. More importantly, Allstate’s valuation metrics are attractive. It has a forward price-to-earnings ratio of 11.6 times, which is 5.6% below the sector median and 27.3% below its five-year average.
In recent years, the company’s strategic focus on improving auto insurance profitability has yielded positive results, with a combined ratio of 94.8 in Q3 2024. However, investors should be wary that Allstate is operating in a competitive market, notably in personal lines of insurance. In the long run, this could put margins under pressure.
And finally, with a 2% dividend yield and a 14-year history of dividend growth, Allstate also offers potential for both income and capital appreciation.
This post was originally published on Motley Fool
