Wall Street sell-side analysts have long leaned optimistic, but their current outlook on S&P 500 (SNPINDEX: ^GSPC) companies has reached an entirely unprecedented level.
Analysts now expect aggregate earnings growth for S&P 500 companies to average 25.5% over the next five years, the highest level ever recorded dating back to 1995.
By comparison, the S&P 500 has historically produced aggregate compound earnings growth of approximately 6.5% annually since 1989, making today’s forecasts look dramatically inflated.
Many on Wall Street attribute this extraordinary optimism to the belief that artificial intelligence will be a transformative technology capable of massively increasing business productivity across industries.
A strikingly similar pattern emerged during the dot-com bubble, when the rapid spread of the World Wide Web generated equally grand expectations for corporate earnings among analysts of that era.
Alongside the surge in long-term growth forecasts, buy ratings among S&P 500 companies have also hit record territory, with 59.5% of all analyst ratings categorized as buys as of the end of May, according to FactSet Insight.
That figure represents the highest proportion of buy ratings on record dating back to 2010, surpassing even the peaks seen ahead of bear markets in 2018 and 2022.
Investment manager Tobias Carlisle offered a pointed warning about placing too much faith in these projections, saying, “It’s a sentiment indicator, not a forecast you should trust. Analysts are notoriously bad at five-year earnings projections, and the estimates tend to be most wrong precisely when they’re most extreme.”
The historic lesson here is straightforward: stocks are valued on future expectations, and when those expectations are sky-high, the bar for further upside becomes extraordinarily difficult to clear.
This dynamic is why even strong quarterly earnings beats can sometimes send a stock lower, as the market had already priced in the good news long before results were announced.
Warren Buffett captured this principle in his 1986 letter to shareholders, writing, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
With analysts projecting long-term earnings growth far in excess of historic averages, there is very little fear visible anywhere on Wall Street at this moment.
History offers a cautionary tale on this point: stocks climbed more than 16% after Buffett published those words in early 1987, only for the index to crash more than 20% in a single day that October.
Investors would be wise to focus on companies trading at a meaningful discount relative to their expected earnings growth, as that approach provides a crucial margin of safety if ambitious forecasts fail to materialize.
