Investors might be undervaluing an entire segment of the stock market, and it could lead to a decade of outperformance.
The S&P 500 has been setting one new all-time high after another in 2024, but not every stock has participated during the current bull market.
Over the last few years, big tech stocks have been the driving force behind the stock market’s increasing value. That trend accelerated recently as innovations among the biggest companies using artificial intelligence (AI) have pushed their stock prices even higher.
The market expects those innovators to produce massive earnings growth over the next few years, and investors have raised their valuations as a result.
But one indicator suggests the domination of big tech might be about to shift. Investors could find a great investment opportunity from an entirely different group of stocks.
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A huge valuation gap that can’t be ignored
One of the most commonly used valuation metrics in investing is the price-to-earnings (P/E) ratio. It tells you how much you’ll pay per dollar of earnings for any given stock. For example, if a company generated $1 in earnings per share over the past year and its share price is $20, it has a P/E ratio of 20.
Since stocks are valued based on expectations for the future, looking at forward P/E can be a better indicator of whether a stock is fairly priced. The forward P/E uses management or analysts’ expectations for earnings over the next year to calculate the ratio, instead of previous earnings.
Looking at stocks as a group and comparing their valuation to historical averages can help determine whether the market as a whole is overvalued or undervalued. And comparing the P/E of one segment of the market to another could help identify investment opportunities.
Currently, the gap between the forward P/E ratios of the large-cap S&P 500 index and the small-cap S&P 600 index is about as wide as it’s been since the start of the century. As of this writing, the S&P 500 has a forward P/E of 21.3, while the S&P 600 sits at just 13.9. The last time the gap…
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