The High Valuation of Palantir Paints a Stark Picture of the Most Expensive Stocks in the S&P 500

Warnings about overvalued stocks in the S&P 500 are becoming common, particularly after two years of significant gains. However, claims of an impending market collapse are nothing new in financial reporting. A closer look at the most expensive stocks reveals substantial differences in their financial prospects, which can be crucial for investors navigating individual equities.

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A Snapshot of the Market’s Performance

Despite concerns about valuation, the S&P 500 has performed remarkably well in recent years. In 2023, the index has delivered a total return of 29.1%, including dividends. This followed a strong 26.3% return in 2022. But it’s worth noting the S&P 500 endured an 18.1% decline in 2022. When viewed together, the index has achieved a cumulative return of 33.5% since the end of 2021.

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This three-year performance, averaging 10.88% annually, aligns closely with its 30-year average annual return of 11.05%, according to FactSet. Stretching the timeframe further, the S&P 500 has delivered an impressive 106% return over the past five years, more than doubling its value despite challenges such as the COVID-19 pandemic, a brief recession, and a turbulent interest-rate cycle driven by the Federal Reserve’s fight against inflation.

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The current forward price-to-earnings (P/E) ratio for the S&P 500 stands at 22.4. This metric, calculated by dividing the index’s price by consensus estimates for the next 12 months’ earnings, exceeds the five-year average forward P/E of 20. It’s nearing the peak of 23.6 seen in August 2020.

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To identify "expensive" individual stocks, analysts often use forward price-to-sales (P/S) ratios. Unlike P/E ratios, the P/S ratio is unaffected by companies reporting net losses due to noncash accounting adjustments or periods of low profitability. For unprofitable companies, this approach provides a clearer picture of their valuation.

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The forward P/S ratio for the S&P 500 reached a high of 3.1 in September 2000, during the dot-com bubble. As of Monday’s close, the index’s forward P/S ratio was 3.0, above its five-year average of 2.5.

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A closer examination reveals the 20 companies in the S&P 500 with the highest forward P/S ratios, based on Monday’s closing prices and consensus estimates from FactSet analysts.

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Among them, Palantir Technologies holds the distinction of having the highest forward P/S ratio in the index. Palantir’s valuation is also significantly higher than its three-year average. In contrast, Nvidia Corp. has a forward P/S ratio of 17.1, which aligns with its three- and five-year historical averages.

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High valuations alone don’t provide the full picture. Revenue growth projections, particularly compound annual growth rates (CAGR), offer additional insights. Analysts estimate the S&P 500 as a whole will achieve a weighted revenue CAGR of 5.9% through 2026.

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Within this group of high-P/S companies, revenue growth projections are notably strong. Nvidia, for instance, stands out with a projected two-year CAGR of 38%, the highest among the group. This is significantly above Palantir’s expected revenue CAGR of 22.6%, even though Palantir’s forward P/S ratio is more than double Nvidia’s.

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The comparison between Palantir and Nvidia illustrates the nuances of investing in high-valuation stocks. Palantir’s valuation suggests high investor expectations, but its projected revenue growth lags behind Nvidia’s. Nvidia, on the other hand, combines a relatively lower valuation with exceptional growth potential, making it a compelling choice for growth-oriented investors.

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While some companies may justify their elevated valuations through robust growth, others could expose investors to greater risks if their financial performance fails to meet lofty expectations. Understanding these dynamics can help investors capitalize on opportunities while mitigating potential losses.

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The S&P 500’s current valuations may seem high, but a deeper analysis reveals significant variation among individual stocks. By examining metrics such as forward P/S ratios and revenue growth projections, investors can identify companies with the strongest potential and avoid those with inflated valuations unsupported by growth prospects.

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Despite the market's challenges and concerns about valuation, the S&P 500 has demonstrated resilience over the years. For investors, the key lies in careful stock selection, focusing on both valuation metrics and growth trajectories to navigate an evolving market landscape successfully.

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