Just how expensive are stocks after all the ups and downs? We check the math.

Mint

18-05-2025

The market has absorbed the early blows of President Trump's tariffs, making up all its lost ground. Yet that rekindles a Wall Street worry from earlier this year: By the typical measures, stocks look very pricey right now.
Following outsize gains in recent years, some analysts entered 2025 concerned that high valuations left share prices especially vulnerable to any hint of trouble in the economy. And so far, stocks have delivered slightly worse returns than bonds this year—even after their recent rebound.
Here is a look at how expensive stocks are currently, and what that might mean for their future performance:
P/E ratios
There are myriad ways to value stocks. The most well-known is the price/earnings ratio.
The most common applications of this metric compare stock prices with a company's past 12 months of corporate earnings, analysts' expectations for its next 12 months of earnings or so-called cyclically adjusted earnings: the average annual earnings of the past 10 years, adjusted for inflation.
When the whole S&P 500 is looked at, all three currently show investors paying a high price for every dollar of earnings compared with what they have paid in the past.
Earnings yield vs. Treasury yield
Wall Street analysts often like to flip the price/earnings ratio upside down, creating an earnings-to-price ratio. Known as the earnings yield, it is expressed as a percentage and sometimes used as a rough guide to the annual return that investors can expect over an extended period.
Investors can then compare stocks' earnings yields with yields on U.S. Treasurys. That offers a sense of how much investors are being compensated to hold riskier investments over ultrasafe government bonds.
Based on real cyclically adjusted earnings, the S&P 500's earnings yield is currently around 2.8%, or 1.4 percentage points above the inflation-adjusted 10-year Treasury yield, according to data from the economist Robert Shiller. That gap, sometimes known as the excess CAPE yield, is well below its historical average, suggesting investors are so eager to buy stocks that they are willing to accept a smaller premium for the risk of losses.
History as a guide
Just because stocks look expensive by these measures doesn't mean they are about to plunge. In periods such as the Roaring '20s and the 1990s tech bubble, frothy markets defied gravity for years.
Still, those rallies eventually ended, leading to years of price declines. There is, as a result, a fairly tight relationship between valuations and what stocks have historically returned over longer periods, such as 10 years.
Measures of relative valuation, like the excess CAPE yield, have been especially good at predicting the relative performance of stocks versus bonds. A smaller excess yield has typically led to a smaller return compared with bonds over the next 10 years; a bigger premium has led to a bigger excess return.
The drawbacks
Aswath Damodaran, a professor at the Stern School of Business at New York University, is widely known on Wall Street as 'the dean of valuation." He says one drawback of a standard S&P 500 earnings yield is that it doesn't account for future earnings growth, effectively treating stocks like bonds with fixed annual payments. He has seen little evidence that valuations can be used to time swings in the market.
Damodaran has devised his own estimate of the risk premium that stocks offer over bonds. His incorporates analysts' expectations for companies' earnings growth. Right now, that calculation suggests that stocks are more reasonably priced than other metrics—although Damodaran says that he uses it as a tool to value individual stocks, rather than a guide to buying or selling the overall index.
Putting them to use
Others are happy to employ valuation metrics in their investment strategies.
As a reasonable guide to future returns, valuations are one tool that investors can use to build portfolios that match their risk tolerance and to make adjustments over time, said Victor Haghani, founder of Elm Wealth. It might make sense for a young person to own 100% stocks, but most people by the middle of their careers want something less volatile, he said.
An investor who put $1 into the S&P 500 some 60 years ago could have outperformed the market by switching completely to 10-year Treasurys when the excess CAPE yield fell to particularly low levels, according to a Wall Street Journal analysis of the data compiled by Shiller.
For example, investing in bonds after any month that the excess CAPE yield averaged less than 1.75%—and stocks otherwise—would have yielded a real annualized return of 6.6%, or 0.5 percentage point more than holding stocks the entire time.
Write to Sam Goldfarb at [e-mail]