Earnings and expectations for future earnings are what drive stock prices in the long run.
The premium investors pay for those earnings, however, fluctuate over time throughout stock market and profits cycles. And that premium is commonly measured by the price-earnings ratio.
In a new research note, Fundstrat Global Advisors’ Tom Lee illustrates how price-earnings ratios move during long bull markets. Specifically, he does so by taking the ratio of the price divided by the peak earnings level of the cycle.
The chart may not be immediately intuitive for most people as it reflects a moving price (P) and a static peak level of earnings (E).
It does, however, do a decent job of showing how high P/Es will get and how long it takes for stocks to get to that peak.
Lee believes the historical patterns provide a precedent for what could be many more years of gains in the stock market.
Arguably one of the more aggressive bulls on Wall Street, Lee sees S&P 500 earnings peaking at $US154 from the $US118 level we’re at today.
“In Figure 4 below we have plotted the current bull market P/E using our implied peak earnings of $US154 against the prior long lived bull markets,” Lee writes. “The S&P 500 is currently 12.9x ($154 peak) and prior bulls peaked at an average of 17x. If we apply the 17x average to our $US154 estimated peak earnings we get a peak S&P 500 value of 2600 at just the “average”.”
Keep in mind that Lee’s $US154 is a forecast.