Understanding Market

# A Rising Market Does Not Always Become a Better Investment

When the stock market has delivered strong returns for many years, it becomes easier to believe that investing is straightforward: buy good companies, wait, and earn roughly what investors earned before you. In the third chapter of *The Intelligent Investor*, Benjamin Graham explains why this can be misleading. Companies can keep developing while their shares become less attractive investments. The reason is simple: the price we pay can rise faster than the profits we are buying.

Imagine a company earning $5 per share. If investors are willing to pay ten times its annual earnings, the share price is $50. Several years later, earnings double to $10, but investors are now willing to pay twenty times earnings. The share price reaches $200. The business doubled its earnings, while the share price quadrupled. Part of the investor’s gain came from the company performing better, and part came from other investors becoming willing to pay more for each dollar of profit.

That second part cannot be taken for granted. Someone buying at $200 is starting from a very different position than the person who bought at $50. Even if the company continues growing, the next investor may earn much less. If earnings eventually reach $15 but investors are only willing to pay fifteen times earnings, the share price will be $225. The company’s earnings increased by 50%, yet the share price increased by just 12.5%, excluding dividends. The business made substantial progress, but the high purchase price absorbed much of the benefit.

Graham saw this distinction in the American market’s history. In June 1949, investors paid approximately 6.3 times trailing earnings for the S&P composite. By March 1961, they paid approximately 22.9 times. Companies had grown, but the price attached to their earnings had risen dramatically too. Looking at the strong returns during that period and expecting them to continue would mean assuming that future buyers would become more generous still.

This does not mean that an expensive market must fall tomorrow. Higher prices can be justified if businesses become more profitable, grow faster or need less money to finance their growth. But those improvements have to be examined. We cannot simply assume that a higher valuation is reasonable because the world has changed, just as we cannot assume it is unreasonable because it exceeds an old historical average.

The recent market data illustrates this problem well. In its September 11, 2026 report, FactSet put the S&P 500 at 25.9 times earnings from the previous twelve months, but only 19.1 times earnings expected over the next twelve months. The first figure was above its ten-year average of 23.6; the second was close to its ten-year average of 19.0. The same market therefore looks more expensive when measured against past profits and more reasonably priced when measured against expected profits. The difference depends on earnings that companies still have to deliver. ([FactSet Earnings Insight](https://www.factset.com/earningsinsight))

For me, this is the useful question: how convincing are those expectations? A share does not become a bargain merely because an optimistic forecast makes its valuation look lower. Equally, a high valuation based on past earnings can be reasonable if the business is genuinely improving. We need to understand what will produce the additional profit and whether that improvement can last.

Interest rates add another part to this judgment. On September 16, 2026, the Federal Reserve raised its policy-rate target by 0.25 percentage points, to 3.75%–4.00%, citing elevated inflation. This decision is directly relevant to Graham’s argument because stocks compete with other uses of our money. ([Federal Reserve statement](https://www.federalreserve.gov/newsevents/pressreleases/monetary20260916a.htm))

The logic is straightforward. If relatively safe investments offer very little income, investors may accept a lower expected return from shares. When safer alternatives offer more, investors have a stronger reason to demand more from stocks too. If a company’s future prospects have not improved, paying a lower share price is one way to obtain that higher expected return. Higher borrowing costs can also reduce the profits of businesses that need new loans or must refinance existing debt.

This does not mean that every rate increase automatically causes stock prices to fall. Investors may have anticipated the decision, and long-term bond yields do not move mechanically with the Fed’s short-term rate. But the decision reminds us why a company cannot be valued in isolation. The same business, with the same expected profits, can justify a different purchase price when the alternatives available to investors change.

What I take from Graham is therefore a habit of asking where returns come from. Did profits grow? Did shareholders receive dividends? Or did investors simply become willing to pay a higher price for the same amount of earnings? All three can contribute to a successful investment, but we should be particularly careful about expecting the last one to repeat.

Before buying, I would rather ask what the company must achieve to justify today’s price than how much its shares have risen in the past. Strong businesses matter. Growth matters. But neither removes the need to judge the price.

**The previous investor’s return began at the price they paid. Ours begins at the price we pay now.**

Adapted from Source: Benjamin Graham’s The Intelligent Investo