Equities

The compelling case for value investors in US equity markets

March 17, 2025 - 6 min read

US markets have once again started the year strongly. While Donald Trump’s return to the White House has helped fuel belief that growth can continue where it left off in 2024, there are increasing signs that markets may not move in completely the same way in 2025 – a possibility that is deeply exciting to some, including at well-known value investor Harris | Oakmark.

Bill Nygren, CIO-US, for Harris | Oakmark notes that while risk has substantially increased in the S&P 500 Index over the past few years, the dramatic spread in valuations between those handful of companies that have driven the S&P 500, and everything else, has created an unusually attractive opportunity set for value investors.

Equity valuations are elevated, so are equity opportunities

While the incredible growth in the mega-cap tech companies in recent years has driven large cap indices to high valuations, well above their long-term averages, it has been a very narrow rally. This has resulted in dispersion, the valuation difference between stocks, becoming 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 31 December 1990 to 31 December 2024. 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:

“We can’t see any logical reason for this widening in valuations. We do not see any evidence in earnings growth, or the sustainability of the return on capital, that indicates the quality differential is wider than it has been historically.

Really, the market right now reminds us a lot of the tech boom in the late 1990s. The differential in growth’s outperformance over 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

“If you add up the five largest holdings in the S&P 500 today, they make up about 27% of the index,” highlights Bill Nygren, CIO-US, for Harris | Oakmark. “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 this was the peak of market concentration, and in the subsequent 40 years these five companies were consistently outperformed by other businesses and could not hold onto their weightings in the index.

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

Source: National Bureau of Economic Research, Empirical Research Partners Analysis, 1950–12/31/2024. Top five S&P 500 holdings as of 12/31/2024, were Amazon.com, Apple, Meta Platforms Cl A, Microsoft Corporation and NVIDIA Corporation.

At the same time as this intense concentration in a small number of stocks, the S&P 500 is 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 around 30% of the S&P 500¹.

While US and global large cap indices are becoming more and more expensive, the average valuation within Harris | Oakmark’s strategies continues to decrease²: “The S&P 500 today sells at a P/E multiple which is about 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.” Bill Nygren adds.

The lower you are, the higher you can go?

While nobody can accurately predict where the stock market will go from here, we can draw conclusions and estimate probabilities, by looking at historical performance. As the chart below illustrates, history is clearly telling us that when markets are at these kind of highs, then it is likely that future returns will be below average.

Source: Source: FactSet, Morningstar Direct. Data as of 12/31/2024. 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, this 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 PE 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.”

When will valuations matter to investors again?

Nobody knows when the current growth and momentum driven market environment will change, and investors will start to care, again, about the price they pay for stocks. However, right now it’s a very attractive environment for stock pickers searching for value and there are already signs that investors may be starting to think differently with the Russell 1000 Value Index outperforming the Russell 1000 Growth Index for the first two months of 2025.

“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,” Bill Nygren explains, adding: “Yes, the market’s at an all-time high, but it’s been driven there by about 20 large technology companies. The rest of the market is priced nothing like that and it’s almost like you’re able to buy the rest of the market at pre-bull-market prices.”

¹ S&P Global, As of 28 February, 2025

² January 6, 2025. https://harrisassoc.com/news-insights/why-the-odds-may-favor-value-stocks/

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