The S&P 500’s P/E ratio is inching toward 30, and for some investors, that number is ringing alarm bells. Historically, when valuations hit this level, it didn’t end well—think the dot-com crash or the correction after the pandemic rally. But others argue that today’s high P/E ratios reflect a different market, shaped by stronger earnings growth and long-term structural changes. So, are these valuations something to worry about, or is this just the price of doing business in a new era?
To understand the debate, it helps to revisit what the P/E ratio actually measures. It’s the price investors are willing to pay for each dollar of earnings. When the ratio is high, it can mean one of two things: either stocks are overpriced relative to what companies are earning, or investors expect future earnings to grow fast enough to justify paying a premium now. In the late 1990s, when the P/E soared above 30, those expectations proved to be misplaced, and it took the market years to recover. Similarly, when the ratio hit nearly 40 in 2020, it reflected an unusual situation—a mix of stimulus-fueled optimism and pandemic distortions that couldn’t last.
Today’s market looks different. Earnings have been growing steadily, and analysts expect S&P 500 companies to post another 12% increase in the fourth quarter of 2024. If that growth continues, the higher valuations could make sense. After all, faster earnings growth naturally supports a higher P/E ratio. This is a key point for those who argue that the market has fundamentally changed. Compared to the mid-20th century, when the S&P 500’s average P/E was around 12, today’s companies are more efficient, more global, and more focused on returning value to shareholders. All of that suggests the “right” P/E ratio might simply be higher now than it used to be.
But there’s a flip side. Even if earnings growth is strong, it’s still subject to economic cycles, competitive pressures, and unexpected shocks. If expectations are set too high and companies miss their targets, today’s valuations could suddenly feel overextended. The history books are filled with examples of markets that looked invincible—until they weren’t.
So where does that leave us? High P/E ratios might be less of a warning sign than they used to be, but they’re not without risk. For investors, it’s a reminder to focus on the fundamentals. Are earnings growing sustainably? Are companies delivering on the expectations baked into their valuations? And how much margin of safety are you comfortable with?
The answer depends on your perspective. For some, the current environment feels like a natural evolution of the market, with higher valuations reflecting stronger fundamentals. For others, it’s a reason to tread carefully, keeping an eye on whether the “E” in P/E can keep up with the “P.” One thing is certain: the debate isn’t going away anytime soon.