Stock prices have been rising faster than earnings are expected to grow.
As a result, valuations have been getting richer, with the price-to-expected-earnings ratio reaching 17.1, the highest level since December 2004.
“The current forward 12-month P/E ratio of 17.1 is now well above the three most recent historical averages: 5-year (13.6), 10-year (14.1), and 15-year (16.0),” FactSet’s John Butters said.
Recently, the disconnect between stock prices and earnings expectations has been more about falling earnings expectations than surging stock prices (see chart below).
“For Q1 2015 and Q2 2015, analysts are now predicting year-over-year earnings declines of 4.1% and 1.1%, respectively,” FactSet’s John Butters noted. “On December 31, analysts were projecting growth of 4.0% and 5.2% for these same two quarters. Most of the decline in the expected earnings growth rates for both quarters can be attributed to analysts lowering earnings forecasts for companies in the Energy sector.”
This of course is due to plunging oil prices.
Butters notes that the price-to-expected-earnings ratio for energy-sector stocks is very high at 27.6.
“Nine of the ten sectors have forward 12-month P/E ratios that are above their 10-year averages, led by the Energy (27.6 vs. 12.0) sector,” Butters said. “The only sector with a forward 12-month P/E ratio below the 10-year average is the Telecom Services (14.0 vs. 14.9) sector.”
Keep in mind, the fact valuations are above average does not mean they will collapse immediately. Valuations tend to drift, which means the price-to-expected-earnings ratio may go much higher.