In markets driven by lofty expectations, some of the world’s biggest companies now trade at price-to-earnings ratios that imply near-flawless future growth. But history warns us that the higher the P/E, the greater the risk of valuation contraction when growth decelerates or market sentiment shifts. This article explores why elevated multiples matter, and how investors can approach high-P/E stocks with both respect and caution.

Valuation multiples above a P/E of 35 have historically signaled that the market is pricing in not only strong growth, but a near flawless scenario for margins, earnings and the macroeconomic environment. Such a valuation is not in itself a mistake. The problem arises when expectations diverge even slightly from reality.

According to long-term studies by Goldman Sachs, stocks trading at extreme multiples have a higher probability of a significant correction when growth slows. The typical risk is not business collapse, but valuation compression, i.e. a return of P…