Buying an S&P 500 index fund is an excellent way to achieve diversification and bet on the growth of the U.S. economy. However, some investors may prefer to mix in individual stocks and exchange-traded funds (ETFs) to invest in companies they believe can help them achieve their investment objectives — whether that is fueling their passive income stream, betting on a certain theme or sector, or trying to outperform the S&P 500.

Vanguard offers over 85 low-cost ETFs for stocks, fixed income, and blends. The best-performing of those ETFs year to date has been the Vanguard S&P 500 Growth ETF (NYSEMKT: VOOG) — which is up 29.2% so far in 2024 vs. a 21.9% gain in the S&P 500. Here’s why the ETF could beat the market again in 2025, and why it is worth buying and holding over the long term.

Betting on the biggest and best growth stocks

Growth investing prioritizes the potential for future earnings and cash flows, whereas value investing focuses on what a company is producing today.

With 231 holdings, the Vanguard S&P 500 Growth ETF essentially splits the S&P 500 in half and targets those companies with the highest growth rates, regardless of valuation. The strategy works well if companies deliver on earnings growth, but can backfire if actual results don’t live up to expectations.

The Vanguard S&P 500 Growth ETF has a whopping 59.7% weighting in its top 10 names — Apple, Microsoft, Nvidia, Alphabet, Meta Platforms, Amazon, Eli Lilly, Broadcom, Tesla, and Netflix. Meanwhile, the Vanguard S&P 500 ETF has just a 34.3% weighting in those same 10 stocks. Given that many of these companies have been market-beating stocks in 2024, it makes sense that the Vanguard S&P 500 Growth ETF is outperforming the S&P 500.

To continue beating the market, these companies must prove that they can grow their earnings faster than the market average, justifying higher valuations.

Understanding growth stock valuations

The following chart shows the forward earnings multiplies for these 10 companies, which are based on analysts’ estimates for the next 12 months. With the exception of Alphabet, none of these stocks look particularly cheap. But context is key.

Take Meta Platforms, for example. Meta is spending a ton of money on research and development, from buying artificial intelligence (AI)-powered Nvidia chips to experimenting with virtual reality, the metaverse, and more. Meta could easily not make these investments and boost its short-term earnings, which would make the stock look dirt cheap.

The same could be said for Nvidia, which could have toned down its pace of innovation to inflate its profitability. Instead, it chose to invest in a new chip that could deliver unparalleled efficiency and cost savings for its customers.

Amazon is known for focusing more on sales growth than on earnings growth. It could easily be a high-margin, inexpensive company if it didn’t reinvest so much of its cash flow into the business.

One reason these companies sport expensive valuations is that investors have been bidding up their stock prices. But another, more important factor is that these companies are not focused on generating as much earnings as possible right now, but rather on charting a path toward future growth that often comes at the expense of near-term results.

For this strategy to work well over time, companies must allocate capital to projects that generate a return on investment. If a company begins spending money on bad ideas, it will fall apart quickly.

A reasonably balanced growth ETF

What separates the Vanguard S&P 500 Growth ETF from other growth funds is that it includes many traditional “value” stocks, like Procter & Gamble, Merck, Coca-Cola, PepsiCo, and McDonald’s, as well as faster-growing companies in non-tech focused sectors, like UnitedHealth and Costco Wholesale. These companies don’t have nearly the growth potential of an innovative tech stock like Nvidia, but they do have track records for steady earnings growth over time. Investors are willing to pay a higher multiple for a stock like P&G relative to its peers because P&G is a high-margin, well-run business that does a masterful job developing its top brands.

While roughly 60% of the Vanguard S&P 500 Growth ETF is in its top 10 holdings, the other 40% of the fund is fairly balanced across companies from various sectors. All told, the Vanguard S&P 500 Growth ETF has a price-to-earnings (P/E) ratio of 32.9 compared to 29.1 for the Vanguard S&P 500 ETF. So it’s not like it is that much more expensive, especially compared to ultra-growth-focused ETFs like the Vanguard Mega Cap Growth ETF, which has fewer holdings and higher weightings in a handful of companies.

Think long-term with the Vanguard S&P 500 Growth ETF

With an expense ratio of just 0.1%, the Vanguard S&P 500 Growth ETF offers investors a low-cost way to target hundreds of top growth stocks without racking up high fees.

Concentrating on high-quality businesses that grow their earnings is a recipe for outperforming other funds or indexes with fewer quality names. However, it’s important to understand that the stock market can do just about anything in the short term.

If near-term results disappoint or investor sentiment turns negative, companies whose valuations are based on future growth will likely sell off more than companies that are valued fairly based on what they are earning today.

Therefore, it’s important to approach the Vanguard S&P 500 Growth ETF with a long-term mindset and the understanding that even the best companies suffer brutal sell-offs.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Costco Wholesale, Merck, Meta Platforms, Microsoft, Netflix, Nvidia, Tesla, and Vanguard S&P 500 ETF. The Motley Fool recommends Broadcom and UnitedHealth Group and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.

Prediction: Vanguard’s Best-Performing ETF in 2024 Will Also Outperform the S&P 500 in 2025 was originally published by The Motley Fool