UBS has highlighted that the S&P 500’s price to earnings (P/E) ratio is currently 22.2x, which is significantly above its 30 year average. While this may raise concerns about overvaluation, UBS argues that the elevated level is supported by solid fundamentals rather than speculative exuberance.
One major factor is the S&P 500’s changing composition. Technology companies now represent 40% of the index’s market capitalization, compared to just 10% three decades ago. These companies are outperforming others in key areas, such as sales growth and profitability. With average sales growth at 10.5% compared to 5.7% for non tech firms, and a P/E ratio of 28.2x versus 18.9x, the prominence of these high performing tech companies has driven up the overall valuation of the index.
Additionally, UBS notes that companies have become more efficient at generating free cash flow. As businesses shift toward less capital intensive operations, both tech and non tech firms are producing stronger cash flow, which has boosted shareholder returns and supports higher market valuations.
The cost of capital is another crucial element. Although Treasury yields are slightly above historical averages, narrowing credit spreads have lowered the overall cost of capital by about 20%. UBS estimates that this has added approximately 4.1x to the S&P 500’s P/E ratio.
Lastly, the current economic environment is contributing to higher valuations. UBS explains that during periods of economic stability, market valuations tend to rise. With recession risks currently subdued, the conditions are favorable for maintaining or even increasing equity multiples.
UBS concludes that while the S&P 500’s valuation is elevated, it is underpinned by strong fundamentals, making further gains in 2025 a possibility.
