Key Points
- Wall Street analysts are questioning whether traditional stock valuation metrics remain relevant.
- The average price-to-earnings ratio for the S&P 500 has been steadily rising for decades.
- The shift is attributed to significant economic changes, including fewer recessions and the rise of the tech sector.
- Analysts say today’s companies are higher quality, with less debt and more stable earnings.
As stock market valuations soar to new heights, many investors are getting nervous, worried that a major crash is just around the corner. However, a growing number of Wall Street analysts are now arguing that the traditional rules for valuing stocks may no longer apply, and that today’s “expensive” market could become the new normal.
For most of the 20th century, the S&P 500’s average price-to-earnings (P/E) ratio stayed in a tight range. But since the 1990s, that average has steadily climbed, from around 14 to nearly 20 today. This suggests that comparing today’s market to the past is a flawed approach.
So why are stocks getting more expensive? Analysts highlight several significant shifts in the economy. First, recessions are now much less frequent than they were in the past. The U.S. has also transformed from an industrial economy to one dominated by technology and services, and the stock market is now heavily weighted toward growth stocks, which naturally have higher valuations.
Other factors include a massive increase in stock market liquidity and a permanent rise in what one analyst calls “profit productivity”—the amount of real profit generated per job.
Strategists at Bank of America agree, arguing that today’s S&P 500 companies are simply higher quality than they were in the past. They have less debt, more stable earnings, and are more efficient. “Perhaps we should anchor to today’s multiples as the new normal rather than expecting mean reversion to a bygone era,” they wrote.
