The S&P 500 index (SNPINDEX: ^GSPC) has risen roughly 33% over the past year, which is a very large increase in a very short period of time. It is hitting all-time highs on a regular basis. It isn't unreasonable for investors to look at the S&P 500 index and think that, perhaps, its valuation is getting a little stretched.
If that thought has passed through your mind, you might want to consider buying the Invesco S&P GARP ETF (NYSEMKT: SPGP). Here's why.
A big problem with Wall Street
Benjamin Graham, the man who helped train the Oracle of Omaha (a k a Warren Buffett), had a story that he used in order to explain Wall Street called "Mr. Market."
To paraphrase Graham, investors are basically partners in a business with a fellow named Mr. Market. He tends to have extreme emotional swings. One day, he will be downbeat and will sell you his piece of the business on the cheap. The next day, Mr. Market will be in an upbeat mood and will pay what seems like an unrealistically high price for your piece of the business. You never know beforehand what mood Mr. Market will be in.
Image source: Getty Images.
That's a pretty nice description of Wall Street, which has a very bad habit of going to extremes on both the upside and the downside. The problem, of course, is in identifying when Mr. Market is being unrealistic.
Sometimes, the pessimism and enthusiasm will be spot on, while at other times, it will be misplaced. This is a relevant story right now because the massive increase in the value of the S&P 500 index over the past year has pushed it to all-time highs. The average price-to-earnings ratio of the S&P 500 index is around 28. That's not a low figure and would normally be associated with a company that was expected to grow materially over the near term.
The S&P 500 index is a cherry-picked list of companies that are large and economically important, but not every company is a growth stock. And just three stocks make up 20% of the index right now, with the top five accounting for a bit more than 25%. That's a lot of concentration for an index that owns roughly 500 stocks, suggesting that right now, Mr. Market's enthusiasm for a small list of companies is driving the overall index's performance.
SPY total return price; data by YCharts.
Growth at a reasonable price to the rescue
While investors can just grit their teeth and hope for the best, there is another option. You can buy the Invesco S&P 500 GARP ETF. It starts with the S&P 500 index, but then takes sales-per-share-growth, earnings-per-share-growth, P/E ratios, financial leverage, and return on equity into consideration. All in, the goal isn't just to find cheap stocks, but to find reasonably priced stocks that are backed by growing businesses -- thus the GARP, for growth at a reasonable price, in the name.
SPY total return price, data by YCharts.
From the 500 or so stocks in the S&P 500 index, the Invesco S&P 500 GARP ETF ends up with a portfolio of around 75 holdings. The really interesting part: The average P/E ratio is only around 14, which is roughly half of the full S&P 500 index's P/E of 28. If you have a value bias (or are just worried about the lofty level of the market), that should be a very interesting statistic.
The Invesco S&P 500 GARP ETF is a long-term story
Over the past year, the Invesco S&P 500 GARP ETF's performance has lagged the S&P 500 index. That's not shocking given that a small number of companies have been driving the S&P 500 index higher. And since only one of the top five holdings in these two funds overlaps, it is clear that the GARP ETF is doing something very different with its portfolio.
That said, as the chart above highlights, the Invesco S&P 500 GARP ETF's long-term performance has proved to be attractive relative to the S&P 500 index. And the best time to buy it, judging from the zigs and zags of the market, is often when the GARP approach has lagged behind for a little while ... just like it is doing right now.
Should you invest $1,000 in Invesco Exchange-Traded Fund Trust - Invesco S&P 500 Garp ETF right now?
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
