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The stock market has been new breaking record highs for nearly a year now, and stocks are high-priced by some traditional historical measures, such as trailing 12-month earnings. With some pundits saying stock market risk is high, this is a good time to note how investors have been compensated for taking the extra risk of investing in stocks instead of parking cash in a so-called riskless asset like 90-day Treasury bills.
The Standard & Poor's 500, an index representing U.S. stocks, returned 125.4% in the five years ended June 30, 2021, making it the No. 1 performer of this diverse group of 13 types of securities investments. A distant second was the 74.9% return on a global index of stocks excluding the U.S.
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Confounding Valuations Of The Largest Five Companies In S&P 500
Published Wednesday, July 21, 2021 at: 9:49 AM EDT
The most important measure of the financial strength of the United States is the Standard & Poor’s 500 stock index. It’s widely watched but constantly surprising.
Of the 500 companies in the S&P 500, the five largest account for 21% of the total value of the much-watched index. You won’t believe where they are currently valued!
Ranked by market capitalization, the five companies are: Apple, Microsoft, Amazon, Google, and Facebook. The Big Five are trading at low PEG ratios, relative to the other 495 stock stocks in the S&P 500 index.
The average company in the S&P 500, as of July 9, traded at a PEG ratio of 3.3%, while the Big Five traded at a PEG ratio of just .98% -- a large discount to the other 500 companies in the S&P 500.
Wikipedia attributes development of the PEG ratio to Mario Farina in a 1969 book. A PEG ratio is a company’s price/earnings ratio divided by its earnings growth rate for the next year. A PEG ratio adjusts the traditional price/earnings metric for valuing a company’s stock by accounting for its expected earnings growth rate.
These five stocks may appear expensive relative to the S&P 500’s average P/E ratio of 22.8, but their earnings growth rate is reflected in the PEG ratios and they are cheap by this important metric relative to the other 495 companies in the index.
For example, the expected earnings growth rate for Amazon is 73%. Amazon's PEG ratio is 0.9% versus the S&P 500's PEG ratio of 3.3.
Stocks are risky investments and they are volatile. Just yesterday, the S&P 500 suffered its worst one-day decline since May, sliding more than 2% during the day before closing down 1.6%. The index shot back up by 1.5% today.
Uncertainty about the risk of the Covid-19 variant as well as inflation are likely to cause big drops in the S&P 500 in the days ahead. Yet stocks are the growth engine of a retirement portfolio and a key in a comprehensive tax-smart investment plan built to last the rest of your life. With volatility high and tax laws about to change, please consider whether the next stock selloff could be a long-term planning opportunity.
The table entitled, “Valuations Of ‘The Big Five’ Versus S&P 500,” was derived from a class for financial professionals by Fritz Meyer, an independent financial economist, on Advisors4Advisors on July 13, 2021.
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