2024-07-24 13:21:51 ET
Summary
- The S&P 500 has had a great run but is now overvalued. Now might be a good time to consider alternative equity funds.
- We can gain insight into a fund’s future return by comparing its return drivers – earnings growth and dividend yield – to its current valuation, as well as the risks of buying the fund today.
- This article compares the earnings, dividend yield, current valuation, safety margin, and estimated future return of fifty-four equity funds and presents the best equity funds to buy today.
- Mid-Cap Value and Energy funds have the best valuation and estimated future returns.
Background
The 20-year price performance of the S&P 500 ( SPY ) is shown below. The index has returned over a 150% gain since bottoming out in March 2020. The index, however, has become increasingly overvalued. The index has had an average price multiple - P/E - of 19.03 over the last 20 years. The price of the index if it was at its 20-year 19.03 price multiple is shown in blue. Black shows the actual price history of the index. Even after last week's 2% drop, the index's 23.6 trailing price-earnings ratio is 24% above its longer-term average. As shown on the chart, the index's price has oscillated above and below its long-term average. The key risk going forward with an S&P 500 fund is its overvaluation and consequential potential to eventually return to its lower mean valuation. Now might be a good time to consider investing in equity funds which are not as overvalued as an S&P 500 index fund.
In choosing an equity fund, an investor should consider not only return potential but also the fund's risk. An investor wants both high returns and minimal risk. He or she might accept a higher risk if it leads to higher performance. But how does one assess risk versus performance? A good approach would be to compare the fund's current price multiple (Price-to-Earnings ratio) to a fair value price multiple given the estimated earnings growth and dividend yields of the stocks that the fund has invested in. One can also estimate the fund's future return using its earnings growth and dividend yield. The future performance estimate can be further enhanced by estimating a justified price multiple - justified from the standpoint of what the market had typically paid over the long term for a given earnings growth rate and dividend yield. This article examines fifty-four equity funds' earnings growth rate, dividend yield, current, fair, and justified price-earnings ratio then estimates and compares fund future returns. A list of the best current funds to buy is presented.
Fund Analysis Approach
Price-Earnings Ratio and PEG
The SPDR S&P 500 ETF ((SPY)) is a good proxy for the S&P 500. Morningstar gives it a 4 (out of 5) star rating. The closing price on July 19 was $548.99....
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For further details see:
Why You Need To Replace That S&P 500 Equity Fund