Investing.com -- UBS noted on Monday that at 22.2x, the S&P 500's price-to-earnings (P/E) ratio is 1.5 standard deviations above its 30-year average, raising concerns about lofty valuations.
However, the investment bank argues that these high multiples are underpinned by rational, fundamental factors rather than mere investor exuberance.
Shift Toward Technology: The bank said the S&P 500's composition has changed dramatically, with tech companies now comprising 40% of the market cap compared to 10% three decades ago.
They add that these firms exhibit superior metrics—10.5% sales growth versus 5.7% for non-tech, and 28.2x P/E compared to 18.9x—driving overall valuations higher.
Enhanced Cash Flows: UBS adds that companies have become less capital-intensive, leading to greater free cash flow.
They explain that both tech and non-tech firms have improved cash flow generation, boosting shareholder returns and justifying higher valuations.
Lower Discount Rates: While Treasury yields are slightly above their historical average, UBS comments that credit spreads have narrowed significantly, reducing the overall cost of capital by 20%. This decline adds an estimated 4.1x points to current P/E multiples.
Non-Recessionary Valuation Trends: Finally, UBS notes that valuations tend to rise during periods of economic stability. With recession risks currently subdued, UBS says equity multiples could continue to climb.
The bank concludes that despite elevated valuations, strong fundamentals support the current market environment, suggesting room for further gains in 2025.