This is the forward price-to-earnings ratio, which compares a stock's price to its expected earnings over the next 12 months.
Enthusiasm around AI is rapidly pushing stocks higher. And while major indices like the S&P 500 are reaching record levels, one metric popular with fundamental analysts suggests that stocks are becoming more attractive, not less.
While stocks have soared, earnings estimates on Wall Street have risen even faster. A year ago, the S&P 500's forward price-to-earnings ratio was 22.4, according to Dow Jones Market Data. Last week, it fell to 20.51, despite the index's 20% gain.
Ahead of second-quarter earnings season, S&P 500 companies are expected to post their seventh consecutive quarter of double-digit earnings growth—analysts are currently projecting more than 23%, according to FactSet. But how long this plateau can be maintained is a big question. Valuations still look extreme relative to history, and recent earnings growth rates have deviated significantly from the long-term trend, Panmure Liberum analysts Joachim Clement and Francisca Reis noted in a report for MarketWatch.
Based on the Shiller CAPE ratio, the S&P 500 is currently valued at approximately 41 times its annual earnings—nearing the dot-com era record a quarter century ago. But earnings growth was more modest back then, and now the S&P 500's earnings per share are growing at a rate 1.8 standard deviations above trend. If earnings were adjusted to a more normal rate, the CAPE would jump to 67.6, surpassing the peak of any other asset bubble in US history. In other words, the situation is approaching a "price bubble on top of an earnings bubble."
In a column for the Financial Times, Clement warned that "supernormal" earnings are unlikely to last forever. He acknowledged, however, that the growth could continue for several more years—such runs often outlast expectations.
The risk of normalization is growing as hyperscale tech giants—Microsoft, Alphabet, Amazon, Meta*, and Oracle—invest in AI data centers, transforming themselves from asset-light to capital-intensive.
Others also point to overly rosy profit expectations, especially for semiconductor companies. Peter Berezin, chief strategist at BCA Research, recalled the profit bubbles of the past—those of banks and developers before the 2007–2008 crisis, when low P/E ratios masked an unsustainable surge in profits.
"Profit bubbles are characteristic of industries with boom-bust cycles: natural resources, airlines, shipping, and, importantly today, semiconductors," he wrote.
He predicted that when the bubble bursts, stocks could fall 30–50%. Similar concerns were expressed by Andy Costan of Damped Spring Advisors and Wall Street veteran Jim Paulsen. U.S. stocks experienced turbulence in June, which carried over into July. But on Monday, the chipmakers surged again: the Nasdaq Composite gained 1.1%, the S&P 500 closed less than 1% below its record, and the Dow Jones set a record above 53,000, according to FactSet.