Dan Chung says the U.S. stock market isn’t overvalued — at least not on a free cash flow basis.
The CEO and chief investment officer of Fred Alger Management, a long-time active growth equity manager, said the firm’s strategy has benefited tremendously from 2024’s raging bull market.
“In January, we saw the biggest month of inflows in three years,” said Chung. At $26.9 billion in assets under management as of Dec. 31, the firm is almost entirely invested in U.S. equities on behalf of clients. Thirty-nine percent of assets are institutional.
Alger is on a recovery path: Following the post-COVID-19 stock rally, Alger, like many growth-centric active managers, “experienced disappointing results and notable outflows, leading its assets under management to decline from $46 billion in mid-2021 to $21 billion by late 2023,” according to Morningstar.
Founded in 1964, Alger remains an independent, privately held firm owned by founder Fred Alger's daughters Alexandra, Hilary and Nicole Alger.
Today, Chung is optimistic. What’s driving the stock market isn’t due entirely to the political shift and Trump’s re-election, he said.
"I continue to be optimistic about the market in the year to multiyear outlook. Near term, the volatility of policy in the Trump administration on multiple fronts — trade, domestic policy, government, for example DOGE — has been a significant driver of investor sentiment, which has obviously turned quite negative" after the euphoria after the Trump election, Chung said. "Fundamentally, we continue to believe that AI will be a major driver of the markets and economy now and in the future. That joins other trends including demographics here and abroad, as well as the political and policy changes from the Trump administration."
What of market valuations? Chung isn’t worried.
“At the level of rates we’re at, that probably makes fair value (in the stock market) a few points higher” from here, Chung said. “I look at the stock market as roughly fair value but not particularly expensive. A 25 multiple on the S&P is reasonable, given the quality of earnings and the currency, current rates and inflation.”
Chung said he thinks of valuations as “being two statements. First, in the longer term, from a 10-year perspective, equities and growth equities got ridiculously cheap after the GFC (global financial crisis). A lot of people didn’t realize that. A lot of the market rise was just getting back to normal, up until COVID,” he said.
Over the past five years, “we’re not so far above average. We’re not yet at extreme valuations that are historically a long-term warning sign.”
Investors shouldn’t only look at price-to-earnings ratios, he said.
“One thing they’re missing when only looking at P/E ratios is the changed nature of earnings in the S&P 500. While earnings are still a critical metric for Alger, we’re also focused on quality of earnings vs. free cash flow per share. Free cash flow is very important. We’ve always used enterprise value to free cash flow as a valuation measure. As a result, when we look at today’s P/E, it’s high if you’re only looking at P/E historically,” but today, earnings are “30% better quality.”
Free cash flow as a percentage of net income in the S&P 500 has risen to 110% in the 2020-2024 period, up from 75% in the 1990s, he estimates.
"We adjust our company models, which is that we focus on operating free cash flow. At Alger we have long recognized this change in the fundamentals of companies within the S&P 500 to much less capital intensive and much more free cash flow generative; so to see the true value within the S&P 500, investors need to look beyond PE and understand free cash flow per share valuation as well."
Chung estimates that on a free-cash-flow per share multiple, in the 1990s a market multiple of an 18 PE was a 24 multiple of free cash flow per share. Today, the PE of the S&P 500 for the next 12 months is 20.7, he said, citing FactSet data.
With free cash flows at 110% of the net income of the S&P 500, "that is only a 19.3 FCF multiple — about 20% lower than the equivalent free cash flow multiple on an 18 PE in the 1990s," he argues.
“Some of our companies — Apple, Meta, Google — their free cash flow is well above earnings. If you adjust for that gap, then a low 20s multiple (on the market), that’s justifiable.”
Chung said it's possible "trade wars will get out of hand, but I remain optimistic about U.S. equities. For example, as I talk with Asian clients, if they want to hedge Asian holdings, the best way to do that against an aggressive U.S. trade policy is to own U.S. assets.”
Alger as a firm has invested on behalf of institutional investors including SEI; Wilshire Associates; the $3.9 billion Oklahoma Firefighters Pension & Retirement System, Oklahoma City; New Orleans Employers ILA' AFL-CIO Pension Fund; and the Wheaton College Trust Co. Its large-cap strategies were among the top performing in the country in 2024.
Last year, the Alger Focus Equity Fund returned 51.8%, while a less-concentrated version of that portfolio, Alger Capital Appreciation Fund, returned 49.7%; Alger Spectra Fund gained 47.6%.
Chung does hear worries among institutional investors.
Pension funds and other institutions tell Chung “they are struggling with their private equity holdings. Their issue is being overallocated to private equity as a result of less liquidations in the past two years. Capital calls continue, distributions and liquidations were much less than expected. That’s overallocation to PE,” he said.
Marks on private equity “will likely be more positive given last year’s stock market. Private real estate is the biggest concern. It’s not liquid,” he said.
Given interest rates, inflation, immigration and tariffs on the construction inputs, “there’s a lot of concern about real estate valuations and the wall of debt that needs to be refinanced every year. There's a lot of five-year debt that is coming due in 2026 and 2027. Refinancing at current rates will be painful. We’ve seen some recovery in institutional real estate in big cities."
Chung also runs the Alger family office, and notes: “We have private credit and PE and real estate. I personally know we would have done better by having more in public equities. We aren’t making any new PE or VC investments. I added to one of our own funds with Alger family money.”
