Valuing Stocks in a Changing Market: The Role of P/E Ratios in 2025

Many investors believe that a low price-to-earnings (P/E) ratio automatically signals a good buy—but the reality is far more nuanced.

As one of the most commonly used metrics for assessing the relative value of a stock, the P/E ratio is calculated by dividing a stock’s current price per share by the company’s earnings per share (EPS) over 12 months. A trailing P/E is based on a company’s actual reported EPS, while a forward P/E relies on projected future earnings. In simple terms, the ratio helps quantify what investors may be willing to pay today for one dollar of future earnings.

Generally, investors seek value by comparing a stock’s current P/E to its historical average, its sector’s average, and the broader S&P 500 average. With the S&P’s long-term average P/E around 18, why is the market currently comfortable with a P/E of 24—especially when that level hasn’t traditionally been considered a value?

Much of the answer lies in shifting market dynamics, beginning with interest rates. Rates directly impact P/E ratios because they influence both the discount rate used in valuing future earnings and the relative appeal of stocks compared to bonds. When interest rates rise, the discount rate increases, lowering the present value of future earnings—this typically leads to lower stock prices and P/E ratios. Conversely, in low-rate environments, investors are often willing to pay more for future growth, resulting in higher P/E multiples. From 2008 to 2022, record-low interest rates near 0% helped fuel historically high valuations. Low borrowing costs also enabled companies to invest aggressively in growth initiatives.

At the same time, companies have become more efficient, with profit margins expanding to historic levels. Improved productivity has supported robust earnings growth. Since 1990, corporate earnings have grown by an average of 6.8% annually, compared to 4.3% in the preceding decades.

You also have to consider capital flows. The past few decades have brought significantly more investment into U.S. equities, from domestic and foreign investors. Gallup reports that 62% of Americans own stock in 2025, up from just 32% in 1989. Higher valuations are a natural consequence, with more money chasing a finite number of assets.

As analysts, we tend to focus on data from the past 10 years, so a current trailing P/E of 24 does stand out relative to that period’s average of 18. However, the forward P/E for the S&P 500 is closer to 21, based on Wall Street’s earnings projections for the next 12 months. Despite ongoing concerns about a potential trade war or economic slowdown, forward earnings expectations have remained largely unchanged.

So far, first-quarter earnings in 2025 have been solid; however, many companies are refraining from offering forward guidance amid continued trade policy uncertainty. The market appears to interpret current tariffs more as negotiating tactics than finalized policy, as reflected in relatively stable forward P/E ratios.

The bottom line: Evaluating stocks isn’t as simple as comparing P/E ratios to historical averages. It requires context—interest rate environments, earnings quality, global capital flows, and investor behavior all play a role. For individual investors, navigating these complexities can be challenging. A trusted financial professional can help you interpret these metrics in a broader context and build a strategy that aligns with your goals and risk tolerance.

If you have questions about your investments, the experts at Henssler Financial will be glad to help: