The S&P 500's forward price-to-earnings ratio has dropped to 19.4, its lowest level since April 2025, even as the index trades near an all-time high. Nvidia, Amazon and Alphabet have all gotten cheaper on a forward-earnings basis this year because their earnings are growing faster than their stock prices.
The S&P 500's forward P/E ratio has fallen to 19.4, its lowest level since April 2025, during the height of the tariff-induced sell-off. The index has more than doubled since the start of 2023 and is up 13.1% year-to-date, well above its typical long-run annual return of 9% to 10%.
That combination, a rising index and a falling valuation measure, happens when earnings climb faster than share prices. Nvidia trades at 24.4 times forward earnings, Amazon at 20.1 and Alphabet at 17.2. Microsoft and Apple, the other two of the five most valuable companies, show a different pattern: Microsoft's P/E ratio has stayed more consistent, while Apple's has climbed higher after its own rally.
Nvidia's earnings are outpacing its stock price
Nvidia's stock is up 21.9% year-to-date and 38.9% last year, yet its valuation has compressed because earnings are rising even faster. In late August, the company reported record profits and high margins despite rising memory chip costs for its second quarter of fiscal 2027. Nvidia is guiding for 70% year-over-year revenue growth in fiscal 2028 as its Vera Rubin platform began shipping in August. The company is also partnering with a consortium of financial institutions to raise $500 billion for AI infrastructure.
Amazon and Alphabet have turned free cash flow negative
Amazon has a track record of reinvesting aggressively rather than buying back stock, while Alphabet has historically stayed free-cash-flow positive and bought back shares regularly. But both companies have turned free cash flow negative as they direct spending toward AI, much of it flowing to chipmakers like Nvidia for compute capacity. Hyperscaler margins could expand once those data center investments start generating revenue.
Expectations stay high for AI spenders
The cheaper valuations put pressure on Nvidia to keep meeting lofty expectations, something it has done so far. A slip-up, or a pullback in spending from one or two key customers, could unwind the compressed valuations quickly. Investors confident that AI spending will pay off see an opportunity to buy these companies at reasonable prices today.
Source: Fool
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