As with many things in life, navigating capital markets would be easier if everyone had a crystal ball or a 1985 DeLorean equipped with a flux capacitor to provide a glimpse of what’s ahead. However, there are some popular metrics that market watchers can turn to for insights on the future of equity markets, including forward price-to-earnings ratios (forward P/E). Forward P/Es are calculated by dividing the current price of an individual stock, sector, or index, by the estimated future earnings, typically analysts’ consensus earnings estimate for the next 12 months.

 

While forward P/E is useful to help assess the market’s confidence in future earnings growth, it’s important to remember that earnings estimates can be wrong. In fact, estimates for S&P 500 earnings at the start of a year, on average, have been about 6% too high. Corporate guidance can be misleading. Economic turning points are often missed. And we say it over and over, but valuations are not good short-term market timing tools, so using them effectively requires patience and flexibility.

 

Sector Level Forward Price-to-Earnings

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After a relatively extended period of stretched valuations for the S&P 500 Index, the recent dip in equities has partially alleviated elevated valuations in some pockets of the market. While most sectors trade above their 10-year average forward P/E, all fall well within their 10-year ranges. Some observations:

 

• Technology remains the furthest above its long-term average despite its more than 9% year-to-date decline, and the skepticism surrounding the U.S. exceptionalism theme. We would argue premium valuations are justified based on the growth outlook. The sector is expected to grow earnings per share by 20% this year, the best among all 11 sectors (second is healthcare at 19%).

• Energy is the furthest below its long-term average due to a skew in long-term data. Energy forward P/Es spiked in early 2020 at the onset of the COVID-19 pandemic, when crude oil futures contracts plunged into negative territory. The importance of oil prices cannot be overstated when evaluating the energy sector.

• Forward P/Es for real estate and utilities are still below their respective averages despite this year’s outperformance, aided by the slight dip in interest rates. Lower interest rates make the dividends these sectors pay out relatively more attractive.

• The consumer discretionary sector is below its average valuation level, not surprisingly given its 14% year-to-date decline amid slowing consumer spending and sharp drops in Amazon (AMZN, -10.9%) and Tesla (TSLA, -41.6%).

• The remaining six industry groups sit less than 3.5 points away from their respective long-term averages in absolute terms.

 

The use of absolute valuation metrics may make some sectors appear overvalued compared to the index or other sectors. So, it’s important to keep in mind that multiples can vary simply based on the sector. As with technology, higher valuations can be justified based on the potential for rapid growth and innovation, and high returns on capital invested. Conversely, utilities companies generally carry lower multiples due to slower earnings growth and greater capital intensity (so lower returns on capital invested).

 

Recent Weakness Pushed Some Sector Valuations Near Averages

Forward price-to-earnings ratio — S&P 500 sectors

• Source: LPL Research, Bloomberg 03/19/25
• Disclosures: All indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. Long-term data is based on the last 10 years. Estimates may not materialize as predicted and are subject to change.

 

Conclusion

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Forward P/Es are no crystal ball, unfortunately, and valuations are only one component in evaluating investment prospects. But they can be an important component when combined with additional metrics. Forward P/Es can offer some insight into how the market views a company’s or sector’s earnings prospects, while also helping investors decide if the earnings growth outlook is strong enough to warrant paying a premium valuation, or if low valuations accurately reflect limited growth opportunities.

 

The LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) maintains a neutral view toward equities overall, expecting modest gains for the S&P 500 in 2025. The Committee holds an overweight preference toward the communication services, industrials, and consumer discretionary sectors, and remains underweight materials, energy, and real estate. The Committee believes the market is currently offering some relative value in terms of the price investors must pay for earnings prospects from communication services, consumer discretionary, and industrials sectors.

 

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