A month ago, we highlighted the intriguing case of Nvidia Corp., where a staggering 553% stock price increase over three years was accompanied by a surprising decrease in its forward price-to-earnings (P/E) ratio. This phenomenon, where earnings estimates rise faster than share prices, is worth another look, especially in the current market climate.
The forward P/E ratio, a critical valuation metric, is the share price divided by the consensus 12-month earnings-per-share estimate among analysts. In the long run, higher stock prices are typically justified when analysts continually raise their earnings estimates, following the classic “beat-and-raise” pattern.
Nvidia’s P/E has historically spiked around earnings announcements, only to decline as analysts adjust their estimates upwards. This pattern appears to be playing out more slowly this time, potentially due to analysts still absorbing the company’s recent report and the excitement surrounding its dominance in the generative AI market.
Remarkably, despite a tripled share price, Nvidia’s forward P/E is currently lower than it was a year ago. This is a testament to the company’s unique position in the market, with no significant competition in the essential GPU market it pioneered for AI applications.
However, Nvidia is not the only company poised to benefit from the AI boom. Other players, even those not directly competing in the GPU market, are expected to experience significant sales growth fueled by AI adoption.
To identify similar companies, we screened the S&P 500 for stocks that had risen at least 50% over the past year while their forward P/E ratios had declined or remained relatively stable. Surprisingly, we found 45 companies meeting this criteria.
This indicates that despite the market’s overall exuberance, there are still pockets of opportunity where earnings growth is outpacing even impressive share price gains. These companies, while commanding high valuations, are demonstrating an ability to deliver on the growth expectations baked into their stock prices.
Investors should take note of this phenomenon. While it is tempting to chase high-flying stocks, it is crucial to consider the underlying fundamentals. Companies where earnings are growing faster than share prices may offer a more sustainable path to long-term investment success.
