S&P 500’s P/E Is Actually Lower Than Official Number, BofA Says

The S&P 500’s price/earnings ratio, amid an ongoing bull market, is a lofty 24.6 —in the 95th percentile for the market going back over the past century—as of last Friday’s close, Bloomberg stats show.

But that figure is misleadingly high because it is based on outdated measures that do not apply to a changed market, according to a report from Savita Subramanian, equity and quant strategist at Bank of America Securities, and her team.

The benchmark index has vaulted 29% over the past 12 months. So as the market charges onward and upward, some investors fear that stocks will ultimately be shucked as too expensive, and the index will tumble painfully—“reverting to the mean,” in finance-speak—with the P/E dropping to the mid-teens.

Subramanian acknowledged that “it’s hard to be bullish based on valuation: the S&P 500 is statistically expensive on 19 of 20 metrics.” Statistical valuation models historically “suggest lower returns over the next decade,” just 3% annually, she pointed out.

But times have changed, Subramanian contended. She based her thesis that the P/E in 2024 is artificially high because the makeup of today’s S&P 500 has changed a lot. If current multiples “are apples,” she wrote, then preceding decades’ “are oranges.”

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In 2024, she went on, the “S&P 500 is half as levered, is higher quality and has similar or lower earnings volatility than in prior decades. The index composition has shifted from 70% asset-intensive manufacturing, financials and real estate in 1980 to 50% asset-light innovation-oriented companies today,” i.e., tech.

The upshot: Once this all becomes clear to investors, they need not fret about over-valued stocks; they should feel free to bid share prices higher.

To Subramanian, the index can climb higher than today, to as much as 5,400 by year-end, which would be up 5% from last week’s close at 5,137, she wrote in a separate research note Sunday. BofA’s is one of the most optimistic forecasts on Wall Street, although Subramanian added, based on historical data, up to three pullbacks are possible up ahead this year.

Another factor favoring a continued S&P 500 rise is that the market is not as risky as it may appear, she maintained. The so-called “equity risk premium”—the excess return investors require over risk-free Treasurys—is exaggerated and likely will come down, she stated. It now is 5.6%, more than the 5.0% historical average, per her report.

But using what BofA believes is a better projection of earnings (adjusting for such items as one-time events and seasonal fluctuations), plus expected lower interest rates, would reduce the ERP to a less-risky 2.3%, in BofA’s view.

“At a basic level,” Subramanian declared, “we question the validity of comparing an index to its younger selves, especially today’s S&P 500.”