Crowding into Quality

<September 15, 2025>

Some investors are comparing the current market cycle to that of 1999—and there are certainly similarities. Technology stocks are once again driving the market higher, fueled by new innovations and growing investor enthusiasm. Equity valuations have reached, or even surpassed, previous bubble peaks. Meanwhile, investor overconfidence and a sense of invincibility feel eerily familiar. Another important—but often overlooked—similarity is the flight into high-quality stocks.

Professional investors love quality stocks. For portfolio managers, one of the most common ways to begin a presentation is with the line: “We invest in high-quality businesses.” Many investors feel a sense of comfort in owning such companies. After all, who doesn’t want to hold a valuable franchise with wide moats? Crowding into quality stocks is good for business and generally makes portfolio management easier.

High-quality stocks were popular during the 1990s bull market, much like they are today. For investors unwilling to chase the Internet mania, they offered a way to participate in the bubble without looking reckless. Some of the best performing non-tech stocks were well-known blue chips, including The Coca-Cola Company (KO).

In the 1990s, Coca-Cola was an exceptional business and must-own stock. It had it all. It was a market leader with dependable earnings growth, enormous competitive advantages, and attractive returns on capital. Coke’s stock performed extremely well throughout most of the decade’s bull market. From the cycle’s start in October 1990 through Coca-Cola’s peak on July 14, 1998, its stock rose 839%—an annualized return of 33%, far outpacing the S&P 500’s 22%. It wasn’t just a place to hide during the tech bubble—it could set you apart from other investors.

Although Coca-Cola’s business grew throughout this period, its earnings couldn’t keep pace with the stock’s sharp rise. As a result, Coke’s valuation expanded significantly, with its price-to-earnings (P/E) ratio doubling between 1990 and 1998. Trading at 48 times earnings at the end of 1998, investors were pricing in very strong growth and a nearly flawless future.

Coca-Cola’s future turned out to be far from flawless. In addition to the collapse of the 1990s stock market bubble, investors were blindsided by several challenges. The Asian Financial Crisis of 1997-1998 hurt emerging market sales, while domestic sales remained flat in the late 1990s due to stiff competition from Pepsi and weakening consumer demand. Distribution and inventory problems further contributed to earnings disappointments. These setbacks stunned investors and ultimately contributed to the CEO’s resignation. From its 1998 peak to its low in March 2002, Coca-Cola’s stock fell by 55%. While the losses were considerable, investors learned a valuable lesson about the risks of overpaying—even for quality.   

Similar to the late 1990s, we believe investors are once again crowding into quality stocks. Walmart is a prime example. After the company released earnings a few weeks ago, I reviewed its quarterly presentation to get an update on consumer spending. While reading through it, I noticed Walmart’s earnings guidance of $2.52 to $2.62 per share. Doing the quick math, I was surprised to see Walmart trading near 40 times earnings. “When did that happen?” I thought. Although I’ve always considered Walmart a high-quality retailer, I couldn’t recall a time when it commanded such an expensive valuation. The current market cycle has certainly been kind to Walmart and its investors!

Similar to Coca Cola’s stock in the 1990s, Walmart shareholders appear to be pricing in very strong growth and a nearly flawless future. While Walmart’s earnings have grown during this cycle, the pace has been slow to moderate—exactly what we’d expect from a massive retailer. Like many mature market leaders we follow, its earnings growth has largely tracked nominal GDP. While there’s nothing wrong with expanding alongside the economy, we believe Walmart’s current valuation demands much stronger growth.  

In addition to earnings, we believe Walmart’s stock looks expensive based on free cash flow. While the share price has soared, its free cash yield has declined meaningfully. In fiscal 2025, Walmart generated $12.66 billion in free cash flow. With a current market capitalization of $800 billion, Walmart’s free cash flow yield has fallen to just 1.6%.

During fiscal 2025, Walmart used most of its $12.66 billion in free cash flow to fund $6.7 billion in dividends and $4.5 billion in share buybacks. It joins a long list of companies continuing to repurchase stock this cycle, regardless of price.

Given its valuation, we believe Walmart should consider halting its buyback program and issue stock instead. At the current price, the company would only need to increase its shares outstanding by about 5% to pay off all $35.6 billion of its long-term debt. In our opinion, issuing stock would provide greater financial flexibility and would be accretive to Walmart’s intrinsic value per share. Our view of being a seller rather than of a buyer appears to be shared with the company’s insiders. If insiders believe it’s a good time to sell, why shouldn’t the company?

Similar to 1999, investors are once again crowding into quality stocks—attempting to participate in another stock market bubble without looking reckless. While quality stocks may feel comfortable to own, their valuations indicate investors are assuming considerable risks. For those who believe losses from overpaying will be temporary, it’s worth remembering that it took Coca-Cola’s stock 12 years to return to its 1998 high.

It's a challenging period for valuation-sensitive equity investors. With the stock market trading at record highs and the Federal Reserve poised to cut interest rates, the good times seem set to continue. We understand how tempting it must be to crowd into quality stocks and ride the wave of asset inflation. The strategy allows investors to benefit from an overvalued market while still appearing responsible. But in our view, chasing many of today’s high-flying quality stocks isn’t responsible investing—it’s conformity, greed, and willful delusion. It’s no different than 1999.  

Eric Cinnamond

eric@palmvalleycapital.com 

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Definitions:

Price to Earnings Ratio (P/E): The PE ratio compares a company's share price with its earnings per share (EPS). Analysts and investors use this to determine the relative value of a company's shares in side-by-side comparisons.

S&P 500: The S&P 500 Index is a list of 500 of the largest public companies in the U.S. These companies are the biggest and most important companies in the country, and represent a broad cross-section of the economy.

Free Cash Flow: The cash a company has left after spending money to support and maintain its operations and capital assets.

Free Cash Flow Yield: A metric that measures the financial performance and valuation of a company by comparing its free cash flow per share to its market price per share. The ratio is calculated by taking the free cash flow per share divided by the current share price. Some investors prefer using free cash flow yield as it reflects the company's ability to generate cash compared to other valuation metrics based on accounting earnings.

Nominal GDP: Nominal gross domestic product (GDP) is everything that a country produces during a certain period at current prices. This means it's not adjusted for inflation or deflation.

Intrinsic value per share: The estimated true or fair value of a single share of a company, based on fundamentals like earnings, assets, and growth potential — not the current market price.

Earnings Per Share: a commonly used measure of a company's profitability. It indicates how much profit each outstanding share of common stock has earned.