{"id":202051,"date":"2025-02-07T10:30:00","date_gmt":"2025-02-07T15:30:00","guid":{"rendered":"https:\/\/ibkrcampus.eu\/campus\/uncategorized\/do-growth-and-margins-justify-higher-sp-500-valuations\/"},"modified":"2025-02-10T09:46:40","modified_gmt":"2025-02-10T09:46:40","slug":"do-growth-and-margins-justify-higher-sp-500-valuations","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.eu\/campus\/traders-insight\/securities\/stocks\/do-growth-and-margins-justify-higher-sp-500-valuations\/","title":{"rendered":"Do growth and margins justify higher S&P 500 valuations?"},"content":{"rendered":"\n

A recent client question:<\/p>\n\n\n\n

Q:<\/em><\/strong> \u201cHave you done any work on the multiple of the S&P 500 and the growth rate and margin\/profitability of the S&P 500? Many strategists say margins are peaking for the S&P 500, margins can\u2019t go higher and that the multiple therefore can\u2019t go higher. But one view is that we have never had a period before when the biggest stocks in the S&P 500 have grown at the rates that NVDA, AMZN, GOOG, AAPL, MSFT etc. are growing, i.e., when JPM and XOM etc. were the biggest stocks in the index they would not have grown at the same rate with the same margins. Therefore, you can potentially make the case for higher multiples now. What\u2019s your take?\u201d<\/em><\/p>\n\n\n\n

 <\/strong>A: <\/strong>Yes, this is part of the market valuation analysis I do, and elements of it are often featured in the Mill Street\u2019s institutional research reports, but I wanted to share my updated response to this topical question here. I last wrote about it here in October<\/a>.<\/p>\n\n\n\n

S&P 500 valuations are higher, but so is profitability<\/strong><\/p>\n\n\n\n

The S&P 500 index P\/E (and other valuation metrics) is indeed high relative to history (though nowhere near the 1999 bubble peak). But the average (median) stock in the S&P 500 is not especially expensive, so it is in fact the biggest companies that are pushing the cap-weighted index P\/E up.<\/p>\n\n\n

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Source: Mill Street Research, Factset<\/em><\/p>\n\n\n\n

Past performance is not indicative of future results<\/p>\n\n\n\n

A key factor is that S&P 500 profit margins are much higher than they have been historically, and the same is true for Return on Equity<\/strong>. These are of course the critical inputs for valuation models, and the moves have been significant: operating margins have risen from 10-11% in the mid-2010s to around 13% now, while ROE has risen from around 16% to just above 20%. Assuming that these readings continue could certainly justify a higher multiple in a traditional valuation model.<\/p>\n\n\n

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Source: Mill Street Research, Factset<\/em><\/p>\n\n\n\n

Past performance is not indicative of future results<\/p>\n\n\n\n

Note that this is very much NOT the case for small-caps, as the S&P 600 Small-Cap index has lower-than-usual margins and ROE, so the higher profitability is clearly a mega-cap trend, not a broad-based pattern for all companies<\/strong>. Margins are not as high outside the US, but the MSCI All-Country World Ex-USA index (ACWI Ex-US) aggregate margins have risen significantly as well, indicating mega-caps outside the US are also getting a profitability boost.<\/p>\n\n\n

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Source: Mill Street Research, Factset<\/em><\/p>\n\n\n\n

Past performance is not indicative of future results<\/p>\n\n\n\n

Why have US mega-caps become more profitable?<\/strong><\/p>\n\n\n\n

 <\/strong>In recent years, it has been a \u201cthe big get bigger\u201d backdrop, and US Technology-related stocks are the dramatic example of that.<\/p>\n\n\n\n

Some key reasons:<\/p>\n\n\n\n