When people say the stock market is “expensive” or “overvalued,” what does that actually mean?
You’ve probably heard these terms on the news or from financial advisors, and maybe nodded along thinking you understood. But let’s break down what’s really being said — because understanding this concept is crucial to being a smart investor.
A Simple Analogy: The Dairy Farm
Imagine buying a farm that produces 100,000 gallons of milk per year. Each gallon sells for $2.50, so after all expenses, the farm makes $100,000 in profit annually.
Now, how much would you pay for this farm?
- Scenario 1: You pay $1,000,000 for the farm. At $100,000 profit per year, it would take 10 years of profits to earn back what you paid. We’d say you bought the farm at “10 times earnings” or “10×.”
- Scenario 2: Lots of people want to buy farms, and competition drives up the price. You end up paying $3,000,000 for the same farm. Same cows. Same milk. Same $100,000 annual profit. But now it takes 30 years of profits to earn back what you paid. You bought at “30 times earnings” or “30×.”
The farm hasn’t changed. The only difference is the price you paid. That’s what it means for something to be “overpriced” or “overvalued” — you’re paying more for the same productive asset.
Here’s the kicker: If you decide in a few years you want to sell this farm, and by then other farm buyers have wised up and are only willing to pay 15× earnings, you’ll only get $1,500,000 back — a 50% loss, even though the farm itself is still producing the same milk.
How This Relates to the Stock Market
A company’s stock works the same way. When you buy stock, you’re buying a share of that company’s future profits. The “price-to-earnings ratio” (or P/E ratio) tells you how many years of current profits you’re paying for.
- A stock trading at 10x earnings costs $10 for every $1 of annual profit
- A stock at 30x earnings costs $30 for every $1 of annual profit
- A stock at 50x earnings costs $50 for every $1 of annual profit
The higher the number, the more expensive the stock is relative to what it actually earns today.
Where Are We Historically?
Over the past 100 years, the stock market (measured by the S&P 500) has typically traded at around 15-17x earnings. That’s been the long-term average, with some variation above and below depending on economic conditions.
In October 2025, the S&P 500’s P/E ratio is 25x, but it hit 30x last month.
That means investors today are paying nearly double what they’ve historically paid for the same dollar of corporate earnings. It’s not the highest it’s ever been — during the late 1990s tech bubble, it briefly exceeded 40x — but it’s definitely expensive by historical standards.
Another metric economists watch, called the cyclically adjusted P/E ratio (or “CAPE ratio”), which smooths out earnings over 10 years to account for economic cycles, tells a similar story. It currently stands at 39.51, which is 124% above its historic average of 17.6.
Even Federal Reserve Chairman Jerome Powell weighed in, stating in September 2025 that stocks are “fairly highly valued” by many measures.
But Wait — Maybe There Are Good Reasons for Higher Valuations?
Here’s where it gets more nuanced. Just because something costs more than it used to doesn’t automatically mean the price is wrong. There might be legitimate reasons why today’s businesses command higher valuations than businesses did decades ago.
Today’s Companies Are More Profitable
In the 1980s and 1990s, the average S&P 500 company had profit margins around 6-7% — meaning for every dollar of sales, they kept 6-7 cents as profit. Today, those margins are closer to 11-12%. Companies are simply more profitable than they used to be. If a business makes more money per dollar of sales, paying a higher multiple makes mathematical sense.
They Can Scale Globally and Efficiently
A retailer in 1985 needed to build physical stores in every city to grow. That required massive capital investment, inventory in each location, and local staff everywhere. Today, a company like Amazon can reach customers worldwide with essentially the same infrastructure. Software companies can sell to one customer or one million customers without building new factories. This ability to scale means future growth potential is genuinely larger — and that’s worth something.
Winner-Take-All Economics
Technology has created markets where one or two companies can dominate globally. Google handles over 90% of internet searches worldwide. These network effects — where a product becomes more valuable as more people use it — create economic advantages that previous generations of companies couldn’t achieve. A dominant position in a winner-take-all market is worth more than a strong position in a fragmented market.
The Economy Has Fundamentally Changed
In 1975, tangible assets — factories, equipment, inventory — made up 83% of the S&P 500’s value. By 2020, that had flipped: intangible assets like software, patents, brands, and data made up about 90% of corporate value.
Intangible assets can scale infinitely at near-zero marginal cost. Microsoft doesn’t need to manufacture physical products to sell to each new customer. This fundamentally changes the economics of what makes a company valuable.
So… Should Valuations Be Higher Today?
The honest answer: maybe. The economy has changed. Business models have changed. Profitability has improved. It’s reasonable to argue that 15-17× was the right valuation for 1985, but perhaps 20-22x is the right valuation for 2025.
The problem is we don’t know for sure. And even if higher valuations are somewhat justified, that doesn’t mean 25-30x is the right number. We might be at fair value, or we might be in a bubble. History will tell us eventually — but only after the fact.
The Market Isn’t One Price — It’s Thousands of Them
Here’s something crucial that often gets lost: When people say “the market is overvalued,” they’re talking about an average. The S&P 500 is 500 different companies, each with its own valuation.
Right now, the market looks expensive largely because its biggest members are very expensive. The top 10 companies in the S&P 500 now make up nearly 40% of the entire index’s value. Many of these mega-cap tech companies trade at valuations well above the market average:
- NVIDIA: ~50x earnings
- Tesla: nearly 200x earnings
- Microsoft: ~37x earnings
- Apple: ~35x earnings
- Even “cheaper” mega-caps like Alphabet: ~23x earnings
Because these companies are so large, their high valuations pull the entire market average higher. But thousands of other stocks trade at much more reasonable prices.
This means you have choices. If you’re concerned about overpaying, you don’t have to abandon stocks entirely — you can be selective about which stocks you own.
Not Everything Is Expensive
While big tech stocks command premium prices, many other sectors and companies trade closer to — or even below — historical norms:
- Financial stocks often trade at 10-15x earnings
- Energy companies frequently trade at single-digit multiples
- Many industrial and consumer goods companies trade at reasonable valuations
- International stocks, particularly in Europe and emerging markets, trade at significant discounts to U.S. stocks
These aren’t necessarily better investments — there are usually reasons why they’re cheaper (slower growth, more cyclical earnings, different risks). But if you’re specifically worried about overpaying, these areas offer alternatives.
The International Opportunity: Cheaper Valuations, Different Risks
Here’s a striking fact: While the U.S. stock market trades at 25-30x earnings, developed international markets (Europe, Japan, Australia) trade around 14-16× earnings, and emerging markets often trade below 12x earnings. That’s less than half the U.S. valuation.
Why the huge gap? There are legitimate reasons:
- Slower economic growth: The U.S. economy has consistently grown faster than Europe and Japan over the past two decades
- Less innovation concentration: The U.S. dominates in high-growth tech sectors; international markets have more exposure to traditional industries
- Political and regulatory uncertainty: Different governance structures, more regulation, and sometimes less shareholder-friendly policies
- Currency risk: Returns can be affected by changes in exchange rates
But here’s what makes the current environment interesting: International stocks are much less likely to experience a severe crash precisely because they’re not priced for perfection.
International stocks have already been beaten down. European stocks, for instance, have dramatically underperformed U.S. stocks for over a decade. Much of the bad news — slower growth, regulatory challenges, geopolitical risks — is already reflected in the lower prices. They’re not priced for a miracle; they’re priced for modest expectations.
This doesn’t mean international stocks can’t fall — everything falls in a global panic. But the risk of a 50% crash is much lower when valuations are already moderate. And if those economies and companies perform even slightly better than the low expectations built into current prices, the upside could be significant.
Adding international exposure (through index funds or ETFs) gives you both geographic diversification and valuation diversification — you’re not putting all your eggs in the expensive U.S. basket.
The catch: If there’s a major market crash triggered by those overvalued mega-cap stocks, it will likely drag down everything else temporarily, even fairly priced stocks. Panic is indiscriminate. But over time, companies bought at reasonable valuations tend to recover faster and deliver better long-term returns.
Lessons From the 2000 Tech Bubble: What’s Similar and What’s Different
The last time U.S. stock valuations hit extremes was the dot-com bubble of the late 1990s and early 2000s. Enthusiasm for internet companies drove prices far beyond what profits could support. Many companies went public without any earnings — some without even a clear path to revenue — and yet their stock prices soared.
When the bubble burst in 2000, the NASDAQ fell nearly 80% from its peak, wiping out trillions in paper wealth. The S&P 500 lost almost half its value before bottoming out in 2002.
What’s Similar Today
Tech Leadership: Just like in 2000, today’s market is heavily driven by a handful of tech companies. In the late ’90s, it was Cisco, Intel, and AOL; today it’s Apple, Microsoft, NVIDIA, and other AI-linked names.
Investor Excitement Around Innovation: Back then, it was the internet revolution; today, it’s artificial intelligence and cloud dominance. Both are transformative technologies that create genuine excitement and optimism.
Concentrated Market Gains: A small group of companies has accounted for the majority of stock market returns. In 1999, the top 10 stocks dominated the S&P 500; the same is true now.
What’s Different This Time
Earnings Power: Many of today’s leading tech companies are highly profitable, with real cash flow and dominant business models. In 2000, most internet companies had little or no earnings to justify their valuations. You literally couldn’t calculate P/E ratios because the “E” (earnings) was zero — or negative.
Valuation Levels: While valuations are high compared to historical averages, they’re not as extreme as they were in 2000. At the peak of the dot-com bubble, the NASDAQ’s P/E ratios were effectively infinite for many firms because there were no profits at all. Today at 25-30x, we’re expensive — but we’re paying for real earnings.
Balance Sheets: Today’s tech giants hold massive amounts of cash and relatively low debt, giving them resilience that dot-com startups lacked. Apple alone has roughly $150 billion in cash. These aren’t fragile companies, one bad quarter away from bankruptcy.
Adoption vs. Hype: In 2000, the internet was still in its infancy — fewer than half of Americans were online. Today, AI, cloud computing, and mobile technology already generate hundreds of billions in real revenue. The infrastructure is built and working, even if future growth assumptions may still be aggressive.
What You Can Do When the Market Is Expensive
Hearing that stocks are “overvalued” can make investors nervous. But high prices don’t necessarily mean a crash is coming tomorrow — markets can stay expensive for years. Here are practical steps to consider:
Do Nothing — Stay the Course and Keep Contributing
If you have a long investment horizon (10+ years), the smartest move is often to just keep going. That means staying invested and continuing your regular contributions. By doing so, you’re dollar-cost averaging — buying shares at all kinds of price levels, expensive and cheap alike.
Over time, this approach has worked far better than trying to time the market. The investors who sold in 1996 because stocks looked expensive missed the massive gains of 1997-1999. Yes, they also missed the crash — but by the time the market recovered in 2007, the person who just kept investing the whole time came out far ahead.
Fiduciary financial advisor Wes Moss says, “Participation beats perfection every time.”
Rebalance Your Portfolio
When stocks rise a lot, they can take up a bigger share of your portfolio than you originally planned. If you started with 70% stocks and 30% bonds, you might now find yourself at 85% stocks just because stocks have grown so much.
Money expert Clark Howard says, “If you’re worried, you don’t have to get out. Just rebalance.”
Rebalancing — selling a little of what’s grown too large and adding to other areas like bonds or international stocks — helps you maintain your intended risk level without trying to predict what happens next.
Build a Cash Cushion
You don’t have to pull money out of the market, but having some extra cash set aside for emergencies or near-term spending needs (anything you’ll need in the next 2-3 years) keeps you from being forced to sell investments at a bad time.
Cash also gives you “dry powder” to invest if stocks do fall significantly.
Look Beyond the Mega-Caps
When the overall market looks expensive, remember that not everything is expensive. Consider adding exposure to:
- Value stocks: Companies trading at lower P/E ratios relative to their earnings or assets. They may not have flashy growth stories, but by definition, they aren’t overpriced.
- Small and mid-cap stocks: These often trade at lower valuations than large-caps and aren’t as dominated by the mega-cap tech names.
- International stocks: European and emerging market stocks trade at significant discounts to U.S. stocks, though they come with their own risks.
- Specific sectors: Financials, energy, and industrials often trade below tech valuations.
Adding these to your portfolio can reduce your exposure to the most overvalued corners of the market while keeping you invested.
Lower Your Return Expectations
This might be the most important one: when you’re paying more for each dollar of company profits, future returns are likely to be more modest. The math is straightforward — if you pay twice as much for the same earnings stream, your return is cut in half (all else being equal).
Adjusting your expectations now — maybe planning for 5-6% annual returns instead of the historical 9-10% — helps you avoid disappointment and keeps your financial plan realistic. It might also help you save more today rather than counting on outsized market returns to meet your goals.
Bottom Line
Understanding what “overvalued” really means is the first step to being a smart investor. It’s not some mystical concept — it’s simply about how much you’re paying for a company’s profits.
Today’s valuations are high by historical standards. However, there are legitimate reasons to think fair value might be somewhat higher than in the past. The key insights:
- The market is a collection of prices. Some stocks are very expensive, others are reasonably priced.
- Expensive doesn’t mean “get out.” It means be thoughtful, stay diversified, and don’t expect historical returns.
- You have options. If you’re worried, you can tilt toward less expensive areas without abandoning stocks entirely.
Stay disciplined. Keep investing. And make sure your risk level matches your time horizon.
