The last few years have been absolutely fantastic for stock investors. The S&P 500 (^GSPC +0.80%) produced a total return of 86% between 2023 and 2025. That's a 23% co al return. The tech-heavy Nasdaq Composite (^IXIC +1.63%) climbed even faster, up 127%, as companies tied to the growth of artificial intelligence led the stock market higher.
But investors have started to fear that the market has overextended itself at this point. Valuations have moved steadily higher over the last three years, and the durability of company earnings has been called into question in 2026. Ironically, investors are now worried about the potential negative effect that AI will have on future earnings for some industries. Still, the market's overall valuation remains fairly high as confidence deteriorates.
Billionaire Bill Ackman, who focuses on buying undervalued stocks for his hedge fund Pershing Square, shared his thoughts on the current market valuation in his most recent letter to shareholders. His conclusion might surprise you.
Image source: Getty Images.
How expensive are stocks right now?
After the recent pullback in the stock market, the S&P 500 now trades for about 20.6 times aggregate forward earnings estimates. That's still well above its long-term average in the mid- to high teens, but considerably below the 22 times earnings multiple it traded for at the start of the year.
The high overall S&P 500 price-to-earnings (P/E) ratio is largely attributable to just a handful of the largest companies. If you look at the 10 largest stocks in the S&P 500, they trade for forward P/E ratios ranging from 19.6 (Meta Platforms) to 184 (Tesla). The majority trade for P/E ratios in the mid-20s, with a median earnings multiple of 26. With the top-heavy S&P 500 (these 10 companies account for 38.5% of the S&P 500's market cap), they have an outsized effect on the index's overall valuation.
Ackman points out that these 10 giant companies are all expected to grow their earnings per share by more than 20% on average over the next two years. As a result, their higher-than-average valuations are justified. In fact, some of them look like bargains at today's price. Ackman notably added to Pershing Square's Amazon position in the fourth quarter and established a position in Meta.
NASDAQ: AMZN
Key Data Points
Ackman points out that many of these mega-cap stocks, which account for a large portion of the S&P 500, have durable structural advantages that should enable them to sustain their high growth rates over the long run. Those advantages include "their global scale, dominant market positions, access to low-cost capital, and leadership in artificial intelligence and related technologies." As a result, Ackman concludes: "The market's P/E multiple is justified and can remain sustainably higher than historic averages."
Howard Marks, the billionaire co-founder and co-chairman of Oaktree Capital, shared a similar sentiment last summer. At the time, the Magnificent Seven traded for even higher P/E ratios than they do today, as their financial results have so far proven the market right, and their stock prices have come down since last fall. Of the Magnificent Seven's high valuations, Marks wrote: "I don't find it unreasonable when viewed against what I believe to be the companies' exceptional products, significant market shares, high incremental profit margins, and strong competitive moats." Instead, he warned investors that the other 493 companies in the index could be what investors should worry about when it comes to valuation.
Finding value in today's market
While the overall valuation of the stock market can be explained by the overall higher valuations and relative prospects of the largest companies in the major indexes, that doesn't mean all stocks are trading at good or even fair values right now.
Even among the top 10 companies in the S&P 500, there are arguably some very overvalued stocks. Is Walmart's forward P/E of 42 justified by its digital transformation, especially as Amazon trades for just 27 times earnings expectations? Is Tesla's 184 earnings multiple worth paying? It probably depends on your expectations for its robotaxi service and line of humanoid robots.
NASDAQ: WMT
Key Data Points
But investors can certainly find many companies in today's market with stocks trading at fair valuations or better. Even if they trade for a higher-than-average P/E ratio or other valuation metric, it might be justified if you can reasonably expect the company to produce higher-than-average earnings growth with relatively high certainty.
At the same time, investors shouldn't simply buy any stock trading at a low valuation in today's market. There may be a good reason for the stock's low price, and it could turn out to be a value trap.
For investors who prefer to use index funds, it's still a reasonable strategy to buy a simple S&P 500 or total stock market index fund. While it means your investment will be heavily concentrated in just a handful of stocks, those stocks appear to have very strong competitive advantages, and, for the most part, trade at good prices.
