Buying a stock is, essentially, buying a share of a company’s earnings, and growth in those earnings is ultimately what drives the stock market. But at any given time, for various reasons, investors are willing to pay more or less for each dollar of corporate earnings, as reflected in the price-earnings ratio, the popular valuation measure for stocks.
Lately, investors have been willing to pay ever-higher prices for their slice of corporate profits, pushing P/Es beyond their historical norms. Based on estimated earnings for the 12 months ahead, the P/E for the S&P 500 was recently 20.3, according to FactSet Research Systems, a financial data firm. That’s greater than both the five-year average of 19.2 and the 10-year average of 17.8.
