Is it madness to invest in the S&P 500 now?

The S&P 500’s been on a tear for three straight years, but are valuations now too high? Or could there be new growth opportunities hiding in plain sight?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

US Tariffs street sign

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The S&P 500‘s performance over the last three years has been truly remarkable. Since December 2022, the US flagship stock market index has delivered a total return just shy of 75%. That’s the equivalent of a 20.5% annualised growth rate – more than double its long-term historical average of 10%!

However, while that’s fantastic news for anyone who’s been buying shares, fears are on the rise that the gravy train may soon come to an end. After all, the US economy’s currently riddled with uncertainty. And it seems that only aggressive AI spending is the reason why GDP continues to grow.

But is this fear overblown?

Is the S&P 500 overvalued?

There are lots of different metrics investors can look at to try and gauge where we stand in the current market cycle. But one of the most popular is looking at the price-to-earnings (P/E) ratio of market indices.

Looking at the S&P 500, the index currently has a P/E ratio of around 30.8. For reference, the long-term average for US stocks is closer to 19.4, which means that if the market were to suddenly return to the average, investors could be hit with a painful 37% downward correction.

But these figures are somewhat misleading. The S&P 500’s weighted based on market capitalisation. That means the largest companies like those in the Magnificent Seven have far more influence over the trajectory of the index versus smaller players. And with more capital being concentrated into these tech giants, the index as a whole has been lifted to lofty levels.

Yet on an equal-weighted basis, the S&P 500’s P/E ratio drops to just 22.5. That’s still above the historical average, but far less extreme.

This suggests if a correction does come along, most of the risk exposure is concentrated into just a small collection of the 500 companies in the index. And that creates some interesting opportunities for stock pickers.

Buying opportunities to consider

One business that’s caught my eye recently is Adobe (NASDAQ:ADBE). The creator of Photoshop and other creative tools has had a rough ride, slipping by over 37% in the last 12 months, while other tech stocks have continued to rally. And as a result, its shares are trading at a relatively undemanding P/E of 20.1.

With new AI tools cropping up, the level of competition for this business has increased significantly. And analysts are growing concerned that it could soon face pressure on its software subscription pricing plans.

However, Adobe has nonetheless been launching its own AI tools to counter this threat. And as a highly cash generative business, the firm’s gross and operating profit margins remain enormous at 89% and 36% respectively.

With so much excess earnings at hand and its share price falling, management’s been buying back its own stock. In fact, the number of shares outstanding has dropped by almost 10% since August 2024 – a pretty rare sight in the tech sector, where stock-based compensation dilutes shareholders rather than supports them.

That’s why, despite the seemingly overstretched valuation of the S&P 500 index as a whole, I think it might be wise to take a closer look at Adobe shares. And it’s not the only undervalued growth opportunity I’ve got my eye on right now.

Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended Adobe. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Mindful young woman breathing out with closed eyes, calming down in stressful situation, working on computer in modern kitchen.
Investing Articles

Be greedy when others are fearful: 2 shares to consider buying right now

Warren Buffett says investors should be greedy when others are fearful. So do falling prices mean it’s time to buy…

Read more »

Thoughtful man using his phone while riding on a train and looking through the window
Investing Articles

Is Palantir still a millionaire-maker S&P 500 stock today?

Palantir has skyrocketed in recent years, making savvy investors a fortune. With the S&P 500 stock down 32% since November,…

Read more »

Aston Martin DBX - rear pic of trunk
Investing Articles

Pennies from an all-time low, is the Aston Martin share price poised to rebound?

How can a business with a great brand and rich customer base keep losing money? Christopher Ruane examines the conundrum…

Read more »

A senior man and his wife holding hands walking up a hill on a footpath looking away from the camera at the view. The fishing village of Polperro is behind them.
Investing Articles

With spare cash to invest, does it make more sense to use a SIPP or an ISA?

ISA or SIPP? That's the dilemma this writer faces when trying to decide how to buy shares. So, what sort…

Read more »

Group of friends meet up in a pub
Investing Articles

Are barnstorming Barclays shares still a slam-dunk buy?

Barclays shares have had a blockbuster run but Harvey Jones now questions just how long the FTSE 100 bank can…

Read more »

Close-up of British bank notes
Investing Articles

5 steps to target a £5,000 second income

What would it really take to earn a second income of hundreds of pounds per month from dividend shares? Christopher…

Read more »

Portrait of pensive bearded senior looking on screen of laptop sitting at table with coffee cup.
Investing Articles

Is it madness to bet against the Rolls-Royce share price?

Harvey Jones wonders if the Rolls-Royce share price has flown too high, and it's finally time for investors to stand…

Read more »

Finger clicking a button marked 'Buy' on a keyboard
Investing Articles

A once-in-a-decade opportunity to buy quality UK shares?

As some of the UK’s top shares of the last 10 years fall to record low multiples, is this the…

Read more »