Professors warn S&P 500’s forward P/E of 21 may mask unusually optimistic earnings forecasts

According to CNBC, the S&P 500 is trading at about 21 times expected earnings over the next 12 months versus a trailing price-to-earnings ratio of about 28, a gap that FactSet data shows is rarely this wide outside market extremes such as 2000. NYU Stern finance professor Aswath Damodaran said the difference between the two ratios reflects the gap between last-12-month earnings and next-12-month expected earnings, while Ohio State University finance professor Itzhak Ben-David said the spread is effectively a measure of expected earnings growth and leaves valuations dependent on companies delivering unusually strong profit gains. Ben-David said median real growth in trailing S&P 500 earnings per share has been about 8% a year since 1989 and that growth at the level implied by today’s spread has occurred in fewer than one in five quarters, mostly during rebounds after earnings collapses in periods including 1994-1995, 2003-2004, 2009-2011, and 2021and 2022. Harvard University economics professor John Campbell said the spread mechanically reflects analysts’ expectations for unusually strong near-term earnings growth and warned that a lower forward P/E should not be treated as proof stocks are fairly valued, noting that approaches such as the CAPE ratio suggest equities are unusually expensive. The report said investors may get more clarity on whether companies can meet elevated profit expectations when second-quarter earnings season begins next week, when firms are likely to provide forward guidance.