Despite recent fluctuations, the S&P 500 has maintained a solid 10% increase for the year, with a notable 4% surge in May. This positive trend is further bolstered by the rise in corporate profit margins during the first quarter. Additionally, Bloomberg reports that S&P 500 companies have announced stock repurchases at the highest rate in nearly two years, indicating that these companies are confident in their future. However, with all this good news, some analysts are beginning to wonder if stock prices are becoming expensive.
As indexes hit records this month, just four giant technology stocks added more market value than the rest of the S&P 500. Microsoft, Apple, and Alphabet, all of which we own, plus Nvidia which we don’t own, have added over $1.4 trillion this month. Just one company made half of the gain, Nvidia. Artificial Intelligence (AI) has been the common theme behind these highfliers. While some fear an AI bubble reminiscent of the dot-com era, a key difference exists: these mega-cap tech titans boast strong earnings, unlike the profitless companies of the past. However, the risk of overvaluation remains. A stock like Nvidia, with a P/E of 66, exemplifies this concern.
The price paid for a company’s stock is important to long-term returns. Pricey stocks driven by high expectations have a greater downside if these expectations aren’t met. That is why we prioritize valuation when selecting investments. While Nvidia has performed exceptionally well, it is currently expensive by traditional metrics.
As investors recognize stretched valuations in specific sectors, market participation will broaden, leading to a shift towards more reasonably priced stocks. Patience, a focus on valuation, and thorough research are key to uncovering these valuable opportunities. We are looking for areas of the market that present good valuations and strong fundamentals to support long-term growth potential.
Small caps have lagged the broader market over the last couple of years. This isn’t unusual. History reveals cyclical trends in small-cap vs. large-cap performance. Currently, small caps appear undervalued compared to their larger counterparts. The last time this valuation gap was this wide was 2000 (coincidentally, the peak year of the dot-com boom), just before a historic small cap run.
Given their attractive valuations, small caps present a compelling long-term opportunity for patient investors. Research suggests that “inefficiencies” in the market are more pronounced in the small-cap space. Additionally, healthy earnings’ growth trends suggest that small caps could outperform in the coming years.
Beyond the U.S. market, we have identified several promising international companies leading their industries. These companies might be overlooked by investors focused on U.S.-based AI leaders, which presents an opportunity to diversify your portfolio with strong international companies with attractive valuations.
At Cardinal Capital, our valuation-oriented methodology leads to superior risk-adjusted returns. This commitment to finding solid companies at reasonable valuations recently earned us a prestigious six-star Top Guns award for our balanced portfolio’s superior risk-adjusted performance over five years. This recognition is a testament to our long-term investment approach and our dedication to delivering strong returns while managing risk for our clients.
We sincerely thank you for your continued confidence and support of Cardinal Capital.
Best,
Cardinal Capital Management, Inc.