Stock market valuations are often described as the price you pay for future earnings. But what if those future earnings are based on overly optimistic guesses? That's the warning from Joachim Klement, an investment strategist at Panmure Liberum, who argues that today's seemingly "reasonable" stock valuations only look that way because they lean on profit forecasts that analysts have a long history of overshooting.
Klement's point is not that stocks are about to crash, but that investors should be aware of how much of the market's current pricing depends on assumptions that may not hold up. If those assumptions get revised down, the impact could be felt twice: once in lower expected earnings, and again in a lower price-to-earnings multiple as investors demand a bigger discount for a less dependable story.
The gap between forecasts and reality
Klement points to a decades-long pattern: since 1992, the S&P 500's earnings per share (EPS) grew about 9.5% a year on average, but analysts' forecasts averaged 22.3%. That's a huge gap. Some of the worst misses occurred around the dotcom bust, the global financial crisis, and the 2020 COVID shock—moments when the economy turned sharply and analysts were caught off guard.
This matters because "forward" valuation metrics—like the price-to-earnings ratio based on expected earnings—bake in those upbeat estimates. The S&P 500's 12-month forward P/E is about 18.9, roughly in line with its 10-year average. That sounds normal. But Klement notes that the multiple only looks normal if earnings rise sharply. The trailing P/E—based on profits already reported—is closer to 26.2, which he says is more stretched and, in his backtests, often more informative than forward measures.
In other words, the market may look reasonably priced on the surface, but that's because the denominator (expected earnings) is inflated. If those expectations come down, the multiple will look a lot less comfortable.
Long-term growth expectations are unusually high
Klement's bigger concern is about long-term growth expectations. He puts the S&P 500's long-term EPS growth forecast at 16.7%—a top-10% reading this century. That kind of optimism is not spread evenly across the market. It's clustered in AI-linked chip and software names like Nvidia, AMD, Intel, Broadcom, Palantir, and Micron.
These companies have been at the center of the AI boom, and their earnings expectations have soared. But when long-term growth assumptions get stretched, the main danger isn't just that stocks look "expensive" today. It's what happens if reality forces analysts to cut multi-year profit expectations.
Klement points to research he cites finding that the group with the most optimistic long-term EPS forecasts tends to lag the market over the following year. That's why he's watching the highest-expected-growth cohort—including those AI names—for "double hit" risk if consensus growth cools.
What it means for investors
For everyday investors, this is a reminder that valuations are not just about today's prices. They are about expectations for the future, and those expectations can change quickly. When analysts are overly optimistic, the market can look safer than it really is.
That doesn't mean you should panic or sell everything. But it does suggest that investors should be aware of the assumptions baked into current prices. If you own stocks in high-growth sectors like AI, it's worth understanding that a lot of the optimism is already priced in. If those expectations get revised down, the stocks could face a double hit: lower earnings forecasts and a lower multiple.
Klement's analysis also highlights the importance of looking at trailing earnings, not just forward estimates. A stock that looks cheap on forward earnings may look expensive on what it has actually earned. That's a useful check for any investor.
As the market heads into a busy earnings season, with AI earnings and central bank decisions in focus, the gap between forecasts and reality will be tested. If companies like Nvidia and others deliver results that fall short of the lofty expectations, the market could see a repricing. On the other hand, if they beat, the optimism may be justified.
For now, the key takeaway is that Wall Street's earnings forecasts are doing a lot of heavy lifting. Investors should understand that the "reasonable" valuations they see today may be built on assumptions that have a history of being too optimistic. That doesn't mean the market is doomed, but it does mean there's more risk than the headline numbers suggest.
