Analysis: The Broken Yardstick – Why Historic S&P 500 P/E Comparisons Are Misleading

This analysis is based on a 2025-12-10 Reddit post titled “The Broken Yardstick: Why Your ‘Historic’ P/E Chart is Lying to You”, which argues that direct historical comparisons of S&P 500 P/E ratios are flawed due to accounting rule changes (mandatory stock-based compensation expensing, intangible asset amortization, immediate R&D expensing) and shifts in index composition.

Market data supports these arguments. As of December 2025, the S&P 500 P/E ratio stands at approximately 29.21 [4]. However, the current Q3 2025 blended net profit margin of 13.1% [1] is roughly double the historical average (1936-2011) of 3.8%-7.2% [2]. This higher profitability directly justifies elevated P/E multiples, as companies generate more earnings per dollar of revenue today than in past periods.

Additionally, the index’s composition has shifted significantly. The “Magnificent Seven” stocks (including Microsoft, Apple, Amazon, Google) now account for 37% of the S&P 500 [3]. These companies exhibit high profit margins, low debt, and resilience—characteristics that command higher valuations. For example, Microsoft has a P/E ratio of 34.05 [0], while GM (a low-margin, high-debt company) has a P/E of 15.42 [0], illustrating that investors pay a premium for higher-quality companies, a dynamic less pronounced in previous index compositions.

1. Accounting Adjustments are Essential
   : The post highlights that accounting rule changes distort raw historical P/E comparisons. While precise adjusted P/E data is not provided, the point underscores the need for normalized metrics to accurately evaluate long-term valuations.
2. Index Concentration Skews Valuations
   : The 37% weighting of the Magnificent Seven means the S&P 500’s overall P/E is heavily influenced by a small number of high-margin companies, making it less representative of the broader market compared to past periods.
3. Margin Sustainability is Critical
   : The current high profit margins (13.1%) justify current P/E ratios, but their long-term sustainability depends on factors like wage growth, competition, and regulation, which could compress margins and reduce the justification for elevated valuations.

• Margin Compression
  : Rising inflation, increased competition, or regulatory changes could reduce profit margins, making current P/E ratios less justified [1].
• Concentration Risk
  : The index’s heavy reliance on seven stocks increases vulnerability to sector-specific shocks, which could disproportionately affect the S&P 500 [3].
• Interest Rate Sensitivity
  : Higher P/E ratios are more sensitive to interest rate hikes; a significant increase could pressure current valuations.
• Accounting Rule Uncertainty
  : Future accounting changes could further complicate historical P/E comparability.

• Adjusted P/E Metrics
  : Using normalized P/E ratios that account for accounting rule changes and margin differences can provide a more accurate view of market valuations.
• Composition Awareness
  : Recognizing the index’s concentration allows investors to adjust portfolio diversification strategies accordingly.

Comparing current S&P 500 P/E ratios (~29.21) to historical averages without context is misleading. Higher current profit margins (~13.1% vs. 3.8%-7.2% historical) and the dominance of high-quality, high-margin “Magnificent Seven” stocks (37% of the index) justify the elevated multiples when adjusted for these factors. However, risks such as margin compression, concentration, and interest rate sensitivity remain, emphasizing the need for nuanced valuation approaches.