The S&P 500 is the most popular index globally and trillions of dollars of assets are indexed to it. It's a market-cap-weighted index of the 500 largest U.S. companies and it's rebalanced regularly. The valuations of the S&P 500 are ahead of its long-term averages. However, within the index, several stocks look even more overvalued.
While there can be several metrics to measure the valuation, the forward or the NTM (next-12 months) PE multiple is the most followed metric. The metric tells us how much investors are willing to pay for stocks for every one dollar of their earnings over the next year.
S&P 500 valuation
Let’s first look at the valuations for the S&P 500. According to a FactSet report dated Aug. 13, the forward PE multiple for the S&P 500 was 21.1x. To put that in context, the multiple has averaged 18.2x over the last five years and 16.3x over the last 10 years. The broader market valuations are running ahead of the historical averages amid low interest rates.
The abundance of cheap money amid monetary and fiscal policy stimulus in the U.S. and other parts of the world has found its way into different assets including U.S. markets. U.S. stocks have outperformed global markets by a wide margin over the last year despite the country being impacted the most by the COVID-19 pandemic.
The forward PE multiples for the S&P 500 have come down amid the recovery in corporate earnings. For example, the forward PE multiple was 21.4x at the end of June. The valuation multiples have contracted as the rise in the index has been lower than the rise in earnings estimates.
Overvalued sectors in the S&P 500 index
According to the FactSet report, the consumer discretionary subsector of the S&P 500 is the most expensive and has a forward PE of 30.8x. The high valuations aren't hard to comprehend. Many companies in the sector still have depressed earnings, which are leading to high valuations.
The information technology sector is the second most expensive S&P 500 subsector with a forward PE of 26.3x. U.S. tech stocks have seen a rerating over the last year. The pace of digitization increased during the COVID-19 pandemic. While the valuations of U.S. tech stocks are off their recent highs, they're still above the historical averages.
Most overvalued stocks in the S&P 500
Now, let's drill down to the most overvalued S&P 500 stocks. Tesla, which joined the prestigious index, would be classified among the most overvalued S&P 500 stocks with an NTM PE multiple of 106x. Meanwhile, the market opinion is very divided on Tesla stock. While some see it as undervalued despite a market cap of over $650 billion, others see the stock as highly overvalued.
With an NTM PE multiple of 52x, Etsy looks like another overvalued S&P 500 stock. The stock is up only about 10 percent in 2021 and is underperforming the S&P 500. Investors have pivoted from growth to value stocks. American Airlines stock also looks overvalued amid the rise in coronavirus cases in the U.S.
In 2020, Warren Buffett sold all of the airline stocks that Berkshire Hathaway was holding, including American Airlines. Airline stocks have come off their 2021 highs and still look overvalued based on the concerns about the recovery in air travel.