COMMENTARIES

From the first day of operations in 1958, Fayez Sarofim & Co. embarked with the belief that staying invested in high quality equities was the right recipe to grow wealth over time. At the onset, our founder believed an owner’s perspective and a global mindset would also be required.

Our last client letter was posted the morning of April 8, 2025 as we passed through the worst market decline of the year. In periods of stress, we remind our clients to think like owners, recognizing that the values of the underlying businesses have not changed as rapidly as share prices have moved. As Fayez Sarofim often said, “nervous energy is a great destroyer of wealth” and can make temporary losses permanent when individuals can no longer stomach the market turmoil.

Despite a rocky period in the tariff-related selloff, 2025 proved to be another good year for the S&P 500 and capital markets. Recession fears and tariff worries pivoted to stronger-than-anticipated earnings growth driven by the prospects of Artificial Intelligence (A.I.) deployment and lower interest rates. More volatile, risk-seeking parts of the capital markets performed very well and sharply outpaced traditionally lower volatility and dividend-paying equities.

Earnings growth proved to be the biggest positive surprise of 2025. Four months into the year, profit margin resiliency and the ability to pass tariffs to customers were the main discussion points. By the end of the year, S&P 500 earnings were revised higher. Once all companies have reported, earnings per share growth could reach 15% and account for the majority of the S&P 500’s 17.9% total return in 2025. However, it was still a tale of two markets. Technology companies grew at twice the pace of the overall index with revenues up 18% and earnings growth exceeding 30%. Outside of the technology-related equities, a more tepid 6% revenue growth translated to 7% earnings growth. Financials were the only other sector beyond Technology and Communication Services to achieve double-digit earnings growth. Healthcare, Real Estate, Materials, and Staples only managed 3% earnings growth while Energy earnings declined commensurate with the oil price pullback.

Capital markets accelerated as the rate of inflation slowed, productivity gains picked up, and GDP growth outpaced expectations. Improved economic growth and lower rates of inflation have been supported by increased domestic and foreign sources of investment. Deficit spending could diminish as this investment translates to job creation, profits, and tax revenues. A new Chair of the Federal Reserve could drive additional stimulus to the economy through reductions to interest rates. These factors could broaden results across economic sectors and for consumers.

Looking ahead, the top 25 companies – representing almost 50% of the S&P 500 by market value – appear poised to generate more than 20% earnings growth in 2026. The share price gains of the Magnificent Seven companies1 have been borne out by the earnings growth statistics. The largest companies have grown and taken share of the S&P 500 by consistently delivering superior revenue and profit growth. Now one-third of the market capitalization relative to about 20% in 2019, these seven companies have generated 55% of the S&P 500 returns over the last five years. Remarkably, the technology-related leaders faced a 23% share price decline through April 8th but subsequently rallied to gain 24% by the end of the calendar year. With 2025 earnings growth of 30%, the price-to-earnings ratio for this group enters 2026 at lower levels than a year ago.

The United States and China are in a new A.I. arms race with significant policy implications for the host governments, the business sector, energy demand, and employment. Demand for data centers with the most efficient chips continues to outpace available supply. As capital spending booms, it will be important that returns on these very large incremental investments remain supportive of profits and free cash flow.

Likewise, this spending is only worthwhile if it ultimately provides customers with the opportunity to benefit and increase their own revenues and cash flows. Historical examples across commodities, railroads, and telecommunications demonstrated that the initial infrastructure wave eventually gives way to companies that benefit from the buildout with improved products, services, and consumer experiences. In the most recent example of building the internet, infrastructure providers like Sun Microsystems, Cisco Systems, and Lucent Technologies were supplanted by leading business models such as Amazon, Facebook, Google, Apple, and Microsoft. As you might expect, we are drawn to the companies that will participate in the longer, more durable, and more profitable subsequent phases for investors.

We strongly believe that investing alongside our clients creates alignment and accountability. Our commitment to fundamental research remains paramount. Identifying long-term market leaders in attractive industries, building relationships with management teams, visiting company operations, and speaking with customers remain at the heart of our investment philosophy. We have added to our research team and continue to build our global reach. From Midland, Texas to Mainland China, we have regularly put our people on the ground to better understand the dynamics in this rapidly changing global economy.

We are grateful that our average client has been engaged at our firm for more than 20 years with some relationships now spanning more than half a century. This long-term orientation has rewarded clients and helped many recognize they have access to the world’s best businesses that adapt to wide-ranging conditions. We are honored to serve like-minded clients that have seen this formula work to benefit their families, their non-profits, and their institutions for decades.

Any projections, market outlooks or estimates expressed in this letter are forward looking statements and are based on certain assumptions. Such projections, outlooks and assumptions should not be construed to be indicative of the actual events that will occur and do not constitute investment advice. Opinions and information included herein are current opinions and information only as of the date hereof or as of the date indicated, and are subject to change without notice. Additionally, while information presented above is believed to be accurate and/or derived from sources which FS&Co. believes to be reliable, FS&Co. disclaims any and all liability as to the completeness or accuracy of the information contained herein.

The volatility of the indices referenced herein may be materially different from that of FS&Co.’s products. In addition, FS&Co.’s holdings may differ significantly from the securities that comprise the highlighted indices. Definitions and descriptions of the indices referenced are available at www.sarofim.com/definitions/
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As used herein “our client portfolios” reference FS&Co.’s model portfolio(s) used in connection with certain managed accounts, and the securities comprising such portfolios may differ from those comprising any individual investor or managed account. The performance of an investor’s account with or managed by FS&Co. may vary from the performance presented herein due to investment restrictions, management fee arrangements, the timing of capital contributions and withdrawals, and the investor’s tax situation.