Is the S&P 500 Forward P/E Ratio of 25 Too High or Too Low
Every few weeks, the same headline appears: stocks are expensive, gravity will pull them down, and the market is bound to fall. I used to believe that narrative, especially as a young trader, until I decided to test it for myself. Instead of fearing valuations, I wanted to measure them. The metric I chose is one of the most widely debated in investing – the S&P 500 forward P/E ratio.
Right now, the market trades near 22–23× forward earnings. But what if it moves up to 25×?
Is that dangerously high, or does it actually reflect today’s growth reality?
The Valuation Framework
To answer this, I built a simple 30-year valuation model. Here are the assumptions:
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The S&P 500 is valued based on its earnings yield.
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Horizon: 30 years, with no residual value.
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Earnings growth is assumed at 12% annually – a reasonable estimate given history and analyst forecasts.
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Inflation is set to the 30-year breakeven rate of 2.31%.
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On top of inflation, I tested different risk premiums to see how valuations change.
Scenario 1: The Goldilocks Case (0% Risk Premium)
Start with the best-case scenario, where the only discounting comes from inflation.
In 2026, the S&P 500 is expected to earn $300. Discounted at 2.31%, that equals $293 in present value. In 2027, earnings rise 12% to $336, which discounted twice at 2.31% gives $321. Carrying this forward for 30 years produces the following snapshot:
Table 1: Goldilocks Valuation (0% Risk Premium)
| Year | Nominal Earnings | Discounted Earnings |
| 1 | 300 | 293 |
| 5 | 472 | 421 |
| 10 | 832 | 662 |
| 20 | 2,584 | 1,636 |
| 30 | 8,025 | 4,045 |
| Total | – | 43,656 |
Forward P/E = 146
This would imply an S&P 500 level of ~43,600 (almost 700% above today). Clearly unrealistic, but it shows the theoretical maximum.
Scenario 2: Adding a 5% Risk Premium
Now let’s add more realism by applying a 5% risk rate on top of inflation.
In this case, 2026 earnings of $300 discounted once become $279, and 2027 earnings of $336 discounted twice become $291. Extending this forward gives:
Table 2: Valuation with 5% Risk Premium
| Year | Nominal Earnings | Discounted Earnings |
| 1 | 300 | 279 |
| 5 | 472 | 330 |
| 10 | 832 | 406 |
| 20 | 2,584 | 617 |
| 30 | 8,025 | 936 |
| Total | – | 16,356 |
Forward P/E = 55
Still very high compared with today’s levels, but more grounded than the Goldilocks scenario.
Scenario 3: Matching Current Market (11% Risk Premium)
Finally, what assumptions replicate the current S&P 500 valuation? The answer: a very steep risk rate of 11%.
At that discount, 2026 earnings of $300 fall to $264 in present value, and 2027 earnings of $336 fall to $261. Over 30 years, the results look like this:
Table 3: Valuation with 11% Risk Premium (Current Market)
| Year | Nominal Earnings | Discounted Earnings |
|---|---|---|
| 1 | 300 | 264 |
| 5 | 472 | 250 |
| 10 | 832 | 233 |
| 20 | 2,584 | 203 |
| 30 | 8,025 | 177 |
| Total | – | 6,528 |
Forward P/E = 22
This lines up almost exactly with today’s forward P/E ratio (~22–23× as of August 2025). But it implies an 11% risk premium, which is unusually high for a diversified index like the S&P 500.
Comparative Summary of All Scenarios
Here’s how the three scenarios compare side by side:
Table 4: Comparative Summary of Forward P/E Scenarios
| Scenario | Risk Premium | Total Discounted Earnings | Forward P/E | Implied S&P 500 Value |
|---|---|---|---|---|
| Goldilocks | 0% | 43,656 | 146× | ~43,600 |
| Moderate Risk | 5% | 16,356 | 55× | ~16,300 |
| Current Market | 11% | 6,528 | 22× | ~6,500 |
This summary makes it clear: today’s valuation assumes an extremely high risk premium. If risk is priced more reasonably (say at 5%), the index would justify a much higher forward P/E ratio.
Of course, even if the overall market looks fairly valued, opportunities vary by industry. We’ve highlighted the top S&P 500 sectors to invest in for 2025
Why a Forward P/E of 25 May Be Justified
So is 25× really too high? By history, yes. The long-term average forward P/E is about 18–20. The dot-com bubble saw multiples over 30, while the financial crisis pushed them below 12. By that lens, 25 looks elevated.
But the world has changed. In the 1990s, 2000s, and 2010s, S&P 500 earnings grew around 5% per year. Since 2020, mega-cap tech companies like Microsoft, Amazon, Nvidia, and Google have consistently grown earnings at 15% or more. Their weight in the index raises the aggregate growth rate. Add the AI-driven productivity boom, and 12% annual earnings growth for the next 3–5 years looks plausible.
If that growth materializes, a forward P/E of 25 is not stretched at all, it may even be cheap.
Conclusion
In the end, the market is always full of stories, some fearful, some euphoric. I used to take the warnings at face value, but running the numbers changed my perspective.
The S&P 500 forward P/E ratio at 25 may look high compared with history, yet it makes sense when you factor in today’s growth dynamics, low inflation, and the strength of mega-cap technology earnings.
Rather than fearing the multiple, investors should ask whether future earnings can sustain it. If they can, then 25 is not a ceiling – it is simply the new normal.