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Would I be willing to pay ten times the price of a good, fast-growing small- or mid-cap? Nope. Would I be willing to pay a bit of a premium for these companies' economies of scale and competitive advantages? Sure. But not nearly enough to demand their huge prices. Yes, these companies are producing strong growth. Netflixhaving incredible runs that have made them expensive-in some cases, extremely expensive. This has led to mega-caps like Amazon and The data shows just how top-heavy the S&P 500 index is: The top 10 holdings in the SPDR S&P 500 ETF Trust collectively have more weight in the index than the 300 smallest holdings combined, according to data from ETF.com Īpple alone has as much weight as the 100 smallest holdings combined. When money goes into these funds, the big guys go up in price more than the smaller members of the index, causing them to gain even more weight in the index, which means new inflows will be even more disproportionally allocated to them. Now, most of these funds' holdings are weighted by market capitalization in reality, many of them give even more weight to the largest companies than would be merited based on market capitalization. As more and more investors have turned to index funds in recent years, it has created a self-sustaining cycle in which the money that goes into index funds goes primarily to larger stocks. Smaller stocks are usually left out of the most popular index funds. I believe this has a lot to do with the swift rise of index funds. Click here to learn from all-time great investors.
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It’s returned 195% since 2003 versus 109% for the S&P 500. Validea Hot List specializes in legendary investor strategies. Looked at another way, since the end of 2005, large-caps have been more expensive only 3.2% of the time using the P/E and just 0.1% of the time-yes, 0.1%!-using the PSR.
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Large-cap stocks are trading at a 21.8% premium to their long-term average using the P/E ratio, and a 24.7% premium using the PSR. That's a 12.0% premium.īut a closer look shows a huge gap between the valuations of larger stocks and smaller stocks. The average price/sales ratio over that 10-plus year stretch has been 1.74, meanwhile. Currently, the average is 21.3, representing an 11.2% premium over the long-term average. Since then, they have traded at an average trailing 12-month P/E ratio of 19.1. Since the end of 2005, my company has been tracking the valuation characteristics of the several thousand stocks in our database, a pretty good approximation of the U.S. But what may surprise you is the source of that overvaluation.Ĭonsider a few numbers. Given that we're now more than seven years into a bull market, that shouldn't be a big surprise.