Equities

Market volatility is creating enticing opportunities for value investors

May 14, 2025 - 6 min read

The compelling case for value investors in US equity markets

Equity markets are often described as a rollercoaster ride. Rarely has that description been so apt as in the white-knuckle-thriller investors have been subjected to so far in 2025. While recent market volatility has been stressful for many people, for active managers and well-prepared investors, it has provided compelling opportunities to purchase high-quality companies at bargain prices.

Bill Nygren, CIO-US and portfolio manager at well-known value investment firm Harris | Oakmark, says it’s an exciting time to be a value investor:

“We think we are in an environment where the S&P 493 might be able to have returns that are superior to the Mag 7, and volatility that is less. For the investor that’s focused on excess return without taking excess risk, there’s a lot of opportunity away from those handful of stocks that have become so popular.”

““For much of the past decade, the S&P 500 has been a very difficult benchmark to beat due to its concentration in mega-cap technology companies that have performed much better than the rest of the market. Yet, in the first quarter of 2025, the so-called “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) declined an average of 16%. In fact, the return on the average Magnificent Seven stock has been negative since early July 2024 and is down 20% since its December peak. That’s the pattern in investing: Once everyone is talking about how great an investment is, it is usually no longer that great.”

Equity valuations are elevated, so are equity opportunities

Although US stocks fell in the first quarter, and investors’ focus shifted to macro events, US large cap indices are still trading at valuations well above their long-term averages. And due to the narrowness of the rally in recent years, dispersion (i.e., the valuation difference between stocks), has become much higher than normal. The graph below shows that the most highly valued stocks in the S&P 500 have seen a significant rise in their price-to-earnings (P/E) valuations over the previous 15 years, however the lowest valued stocks have barely risen at all.

S&P 500 P/E ratios by decile

Source: FactSet. Harris Associates analysis depicted 12/31/1990-3/31/2025. P/E ratio is last 12 months (LTM).

For Daniel Nicholas, client portfolio manager at Harris | Oakmark, this is another proof point showing the markets haven’t been ruled by rationality in recent times:

“Really, the market right now reminds us a lot of the tech boom in the late 1990s. The differential in growth’s outperformance of value in recent years and overall valuations are eerily similar; the excitement over AI is reminiscent to the buzz over the advent of personal computing. Companies with strong returns on capital and per share value growth are being left behind just because they aren’t in the Magnificent 7 or direct AI plays. It’s times like these, with both dispersion and valuations very high, that value investors tend to outperform.”

Today’s S&P 500 is riskier than you think

“As of April 2025, if you add up the five largest holdings in the S&P 500, they make up about 25% of the index,” highlights Bill Nygren. “While this concentration has been widely reported, what hasn’t been as widely reported is that you need to go back to 1957 to find a similar level of concentration. In 1957, around 26% of the S&P 500 was concentrated in five names: General Motors, General Electric, Exxon, DuPont, and AT&T.”

The graph below shows that after this previous peak of market concentration in the 1950s, these five companies were consistently outperformed by other businesses and could not hold on to their weightings in the index over the next 40 years.

Top five S&P 500 holdings’ share of market capitalization

Source: National Bureau of Economic Research, Empirical Research Partners Analysis, 1950–3/31/2025. Top five S&P 500 holdings as of 3/31/2025, were Apple, Nvidia Corp, Microsoft Corp, Amazon.com and Meta Platforms Cl A.

Today, the S&P 500 is not only intensely concentrated in a small number of stocks, but also increasingly concentrated from an industry perspective. In 1957, the top companies were diversified across industries including automotive, industrial, oil, communications and chemicals. Today, the concentration is almost all in one industry, information technology, which accounts for 30% of the S&P 500¹.

While US and global large cap indices have become much more expensive in recent years, the average valuation within Harris | Oakmark’s strategies trades in the low double digit range². As Bill Nygren observed in January this year: “The S&P 500 today sells at a P/E multiple which is nearly twice as high as the P/E level that we have in Harris | Oakmark large cap strategies. That spread is unusually wide and we think tilts the odds in favor of the value investor. One of the nice things for a value investor today, because the S&P 500 has been so concentrated in large cap technology companies, the cheap stocks are spread out across most other industries so I think there’s an unusual opportunity to put together a very well diversified portfolio today in low P/E stocks across lots of industries.”

The lower the price, the higher the potential reward

While nobody can accurately predict where the stock market will go from here, we can make observations and estimate probabilities by looking at historical performance. As the chart below illustrates, history shows that when markets were at these kind of highs, below average returns have followed.

S&P 500 forward price-to-earnings (P/E) and subsequent five-year annualised returns

Source: Source: FactSet, Morningstar Direct. Data as of 3/31/2025. Returns are 60-month annualized total returns measured monthly, beginning 08/31/1999.
Past performance is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. All returns reflect the reinvestment of dividends and capital gains and the deduction
of transaction costs. .

However, as mentioned before, the high overall valuation only applies to the S&P 500 Index as a whole. There is significant opportunity for active managers, and savvy investors, to put together a diversified portfolio at a much lower P/E multiple.

There are also opportunities for undervalued businesses to take advantage of the situation. According to Daniel Nicholas: “Many of our holdings are using their extra cash to return capital to shareholders, either by increasing dividends, or repurchasing stock or other methods. We believe purchasing their own undervalued, low P/E shares can be the best acquisition a company can make.”

Are valuations starting to matter to investors again?

Markets are in a period of intense volatility due to significant change happening at a global macroeconomic and geopolitical level. While nobody knows how long this period of change and volatility will continue, and exactly how it will reshape the global economy and equity markets, there are signs that investors are starting to return to fundamentals. Investors may be starting to care, again, about the price they pay for stocks. The Russell 1000 Value Index outperformed the Russell 1000 Growth Index for the first three months of 2025 by more than 10%³, yet despite this outperformance, it remains a very attractive environment for stock pickers searching for value.

For Bill Nygren the US stock market already looked attractive for value investors due to the dramatic spread in valuations, this latest bout of market volatility has made the opportunity set even more compelling.

¹ Spglobal.com, as of 31 March, 2025

² Source: Harris l Oakmark, as of 31 March, 2025 the Harris Large Value Strategy had a P/E of 11.6 vs 20.3 in the S&P 500

³ FTSE Russell Index Calculator. From 1 Jan. 2025 to 31 March, 2025.

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