The recent years have seen remarkable gains for stock investors, with the S&P 500 (^GSPC) delivering a stunning total return of 86% between 2023 and 2025. This impressive figure reflects an annualized return of approximately 23%. In comparison, the tech-centered Nasdaq Composite (^IXIC) soared even more dramatically, climbing 127%, driven primarily by companies associated with the burgeoning artificial intelligence sector.
However, a sense of apprehension has begun to take hold among investors, who are increasingly concerned about the market’s potential overextension. Valuations have climbed steadily over the past three years, leading to growing skepticism about the sustainability of corporate earnings in 2026. Intriguingly, there are emerging fears that advancements in AI could negatively impact future earnings in certain industries. Overall market valuations remain elevated, while investor confidence appears to be waning.
Prominent hedge fund manager Bill Ackman, known for focusing on undervalued stocks through his firm Pershing Square, recently shared insights on current market valuations in a letter to shareholders, offering a surprising perspective in the face of prevailing concerns.
Currently, the S&P 500 trades at approximately 20.6 times its aggregate forward earnings estimates. While this figure is above the historical average, typically in the mid- to high teens, it marks a decline from the 22 times earnings multiple observed at the beginning of the year. The high price-to-earnings (P/E) ratio of the S&P 500 is largely driven by a select few large companies. The ten largest stocks in the index carry forward P/E ratios that range significantly, from 19.6 for Meta Platforms to an astonishing 184 for Tesla, with many others in the mid-20s, culminating in a median earnings multiple of 26. These top companies represent a staggering 38.5% of the S&P 500’s market capitalization, thereby exerting substantial influence over the index’s overall valuation.
Ackman notes that these ten dominant firms are expected to witness an average growth in their earnings per share exceeding 20% over the next two years, which he argues justifies their elevated valuations. Furthermore, he has strategically increased his holdings in Amazon and initiated a position in Meta, reflecting his belief in their potential.
Ackman emphasizes the structural advantages that many of these mega-cap stocks enjoy, including “global scale, dominant market positions, access to low-cost capital, and leadership in AI and related technologies.” He concludes that the market’s current P/E multiple is not only justified but could remain sustainably higher than historic averages.
Similarly, Howard Marks, co-founder of Oaktree Capital, resonated with this sentiment last summer. Despite the high P/E ratios of the so-called ‘Magnificent Seven’ stocks, which had indeed been even higher previously, Marks maintained that their exceptional products, significant market shares, and robust profit margins warranted their valuations. He cautioned, however, that investors should be wary of the other 493 companies in the index that could present greater valuation risks.
In navigating the current landscape, while the overarching valuation of the stock market is influenced by the prominent prospects of its largest players, not every individual stock offers favorable value. For instance, questions arise about the justification of Walmart’s forward P/E of 42, especially against Amazon’s 27, while Tesla’s lofty 184 earnings multiple invites scrutiny tied to future innovations in autonomous services.
Nonetheless, savvy investors can uncover companies trading at fair or even advantageous valuations, particularly those with robust growth expectations that seem reliable. If a stock is priced low, there may be significant undercurrents explaining its dip—potentially marking it as a value trap.
For those leaning towards index funds, investing in simple S&P 500 or total market index funds seems reasonable. Although this approach may lead to significant concentration in a small number of stocks, those companies are generally believed to possess strong competitive advantages and appear to be well-positioned in terms of valuation.
