Are You Paying A Fair Price For What’s Inside VOO?
The popular index fund trades at a premium to its own history, but the real question is whether the growth of its biggest holdings actually earns that price.
The Vanguard S&P 500 ETF (VOO) currently trades at a trailing price-to-earnings ratio of 28.3, a notable step up from its 5-year average of 24.7. Before you even consider the potential for stock market growth, you have to weigh that against a simple alternative: the 10-year US Treasury yields 4.6% today. That sets a high bar for any investment, including one as foundational as this.
A Higher Price Tag Than Usual
Paying a premium isn’t necessarily a mistake, but you should know when you’re doing it. Today’s price for VOO is about 14% above that recent 5-year average valuation. You are, in effect, paying more for each dollar of the underlying companies’ past earnings than investors have on average over the last half-decade. The question is whether the basket of companies inside the fund is delivering enough to justify that higher entry point.
Is The Growth Engine Earning Its Keep?
The justification for today’s price rests almost entirely on future growth. While the trailing valuation looks rich, consensus estimates put one-year earnings growth for the fund’s holdings at about 18%. Rather than a broad market forecast, this figure is powered by the specific, concentrated group of companies at the top. The fund’s largest holdings grew their earnings per share about 56% over the past year. Because VOO tracks the Standard & Poor’s 500 Index, its fate is tied to its biggest members, namely Nvidia at 7.5% of the fund, Apple at 6.6%, and Microsoft at 4.3%. The health of the entire fund’s valuation really depends on whether these giants continue to deliver.
The Unavoidable Math Of Opportunity Cost
Here is the sharpest point of caution. The aggregate earnings yield of the fund’s holdings is 3.5%. With the 10-year US Treasury yielding 4.6%, you are looking at a negative risk premium. In plain terms, you are accepting a lower immediate earnings yield from this basket of stocks than you could get from a risk-free government bond. The trade-off is clear: you are forgoing current yield in the hopes that future earnings growth will deliver a return that more than makes up for the risk you’re taking.
What An Index Owner Is Buying Today
So, is today’s price justified? The data suggests the premium valuation is largely earned by very strong earnings growth from the handful of companies that drive the index. The sober counterpoint is that you are not being paid, via earnings yield, to take that equity risk versus holding a simple Treasury bond. Owning an index fund means you own every company in it at the prevailing price, without discretion. The key factor to watch is whether that estimated 18% earnings growth actually arrives. If it does, it makes today’s price look far more reasonable. If it falters, the justification for paying this premium weakens considerably.
How Do You Know You Picked The Right Fund?
VOO is paying up for fast-growing holdings. The real question is whether every fund charging a premium has earned it. An ETF gives you instant, diversified exposure to an idea, which is exactly why so many investors start there. The trouble is that a good idea bought at the wrong price makes a mediocre investment, and few ETF buyers ever check how their fund’s valuation and risk stack up against the alternatives.
Our ETF Valuation and Performance Scorecard does that across the whole equity universe at once, ranking every fund by risk-adjusted return and then showing what each one costs versus its own history. And for the part of a portfolio where you would rather a system did the choosing, the Trefis High Quality (HQ) Portfolio holds 30 individually screened names, re-balanced by rule, with a track record of outpacing a benchmark that combines the three major indices – the S&P 500, S&P Mid-cap, and Russell 2000.