The S&P 500 Hasn't Looked This Cheap Based on a Popular Metric in Decades. Should You Buy Stocks Now?

The S&P 500 (SNPINDEX: ^GSPC) might not seem cheap today. The benchmark index for large-cap stocks trades close to an all-time high. Many analysts have warned about concentration among big growth stocks, some of which have very high valuations relative to earnings. The Buffett indicator, which compares the combined market cap of all U.S. stocks to the U.S. gross domestic product, is off the charts. The CAPE ratio is at levels last seen at the height of the dot-com bubble. The list goes on.

However, stock prices are supposed to reflect the future earnings or cash flows of the companies behind them. In that regard, stocks look cheaper than they've been in at least 31 years. The S&P 500 price/earnings-to-growth (PEG) ratio, which compares the forward price-to-earnings (P/E) ratio to earnings growth expectations, sits around 0.7 as of this writing based on analysts' projections.

In his book One Up On Wall Street, famed investor Peter Lynch said a PEG ratio below 1 indicates the market undervalues a stock. The S&P 500 PEG ratio has dipped below 1 just four other times since 1995. Today, it looks like the market is undervaluing the entire U.S. large-cap market by the widest margin ever. Does that mean investors should be buying as much stock as possible right now?

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Looking at both sides of the equation

There are two components to the PEG ratio: the P/E ratio and the growth expectations.

The S&P 500 currently trades for a forward P/E ratio of about 19.2. That's below the five-year average for the index (19.8), but above the 10-year average (19). It's well above the 25-year average (16.7), and if you go back even further, stocks have tended to stick around that mid-teens earnings multiple.

Unlike other periods when we've seen the P/E ratio climb well above the historic average, the PEG ratio is actually declining. In the late 1990s, as the P/E ratio climbed from 12 to 24, the PEG ratio went from just over 1 to more than 1.5. Earnings growth expectations went from around 11% in 1995 to around 16% by the late 1990s. Valuations moderated ahead of the peak of the dot-com bubble, even as earnings growth expectations continued to climb past 18%.

Today, the forward P/E ratio of the index is falling even as prices continue to climb. That's because analysts have extremely high expectations for earnings growth well into the future. The consensus calls for 26.8% earnings growth in the fourth quarter of 2026, 15.4% earnings growth for calendar 2027, and average annualized earnings growth of 27.3% over the next five years. That latter figure is what's used to calculate the PEG ratio. It's worth noting that the five-year average figure is also up from about 18% at the start of 2025.

Those earnings expectations have been driven by optimism about the potential for artificial intelligence to improve productivity and provide significant earnings opportunities, especially among the largest companies in the United States.

Should you buy stocks now?

Before piling into stocks, it's important to consider the biggest flaw in the PEG ratio. It depends on an accurate outlook for future earnings. Expectations for annualized earnings growth of 27.3% are well outside of ordinary growth for the S&P 500.

What's more, analysts tend to be an optimistic group. As mentioned, earnings growth expectations continued to climb through the turn of the millennium, just ahead of the lost decade in the S&P 500. The only time long-term earnings expectations have dipped below 10% since 1995 was in the depths of the Great Recession. Meanwhile, earnings have compounded at an average rate of just 7.5% over the last 31.5 years.

That is to say, analysts are very likely overestimating the future earnings growth for the S&P 500. But with the PEG ratio falling to 0.7, there's a lot of room for error, and stocks can still be a great value right now. In fact, many of the world's largest companies have the potential to deliver earnings-per-share growth in the high teens, or even faster, over the next three to five years. Many of their P/E ratios sit in the 20s. Those could be great investments.

It's also worth noting that the PEG ratio doesn't need to be below 1 for the S&P 500 to continue climbing. As mentioned, it's very rare for the PEG to fall below that level, and it's even rarer for prices to prove so cheap relative to realized growth when all is said and done.

The market's optimism, reflected in both stock prices and growth expectations, isn't without justification, and investors should remain bullish on stocks over the long run. The current PEG ratio might not reflect an unprecedented buying opportunity, but it also suggests there's still room for stocks to climb higher from here.

Adam Levy has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.