Here's a hint: look beyond the ten biggest companies to find the next big stock market winners.

The S&P 500 has rebounded to all-time highs, up over 10% year-to-date after recovering from a dip of over 5% in April.

Earnings season is upon us, with over 90% of companies already reporting results. Using FactSet’s blended formula that combines reported earnings with remaining estimated earnings, analysts expect 5.4% year-over-year earnings growth in the first quarter. The index's top five contributors to earnings growth are Nvidia, Alphabet, Amazon, Meta, and Microsoft. Excluding these five companies, year-over-year earnings growth is estimated to decline 2.4%.

Medium-size companies represented by the S&P 400 have advanced 8% this year, broadening the rally. Small companies remain far behind, with the S&P 600 up only 1% year-to-date.

The Dow Jones Industrial Average looks to pierce through 40,000 for the first time in history. The index of 30 blue chip companies, up nearly 5% in 2024, is price-weighted rather than market-cap-weighted. The Dow has lagged other indexes for many years as market-cap indexes continue to benefit from the outperformance of mega-cap companies. However, the potential of these large companies to spend hundreds of billions of dollars on hardware and software in the next few years to develop artificial intelligence and alternate reality environments is a source of great anticipation. It will be interesting to see how this investment will shape their future earnings growth.

The S&P 500's price-to-earnings ratio continues to trade at a premium to historical valuations. According to FactSet, the index's forward P/E is 20.4, nearly 15% higher than the ten-year average of 17.8. Analysts expect 11% earnings growth in 2024, followed by 14% growth in 2025.

Investors might consider comparing the current dividend yield versus historical averages to evaluate the attractiveness of the index. The strong performance of the S&P 500 has pushed the dividend yield lower, currently around 1.4%. This is down from 1.8% in October 2022 and lower than the 2% or more experienced during most of the 2010s. If earnings are as robust as analysts expect in the next few years, dividend increases will likely follow.

Small and medium-sized companies continue to trade at a discount to their historical averages and well below large companies. Stock pickers can still find bargains looking beyond the largest top 10 companies. The challenge with investing is the past is history. We must navigate the unknown future. Buying solid companies at fair valuations remains the best way to make money reliably over time.

The solid companies profiled in this month's Investor Advisory Service are both midsized companies. Growth companies with annual revenues below $10 billion often have the optimal mix of risk and return that long-term stock investors find most attractive. The first pick in the issue is a leader in the apparel business with superior margins and an ultra-loyal customer base. Our second selection is a software company focusing on customer support solutions for some of the largest enterprises in the world.

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The commentary is excerpted from the issue of the Investor Advisory Service newsletter published at the end of May. To receive commentary like this in a more timely matter and receive actionable stock ideas each and every month, subscribe today. The Investor Advisory Service stock newsletter was named to the Hulbert Investment Newsletter Honor Roll for the 14th consecutive year for outperforming every up and down market cycle since 2007

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