Navigating the stock market can be confusing and full of turbulence. That is why it’s handy to have a compass at hand, some guiding principles to keep you in the right direction. And one to remember is—over the long-term stock prices follow earnings.
Sometimes stock prices can behave like toddlers in a supermarket—darting around, reacting to every noise, and occasionally throwing a tantrum for no clear reason.
No matter how noisy markets get, stock prices and earnings eventually reconnect. Sometimes it takes months. Sometimes years. But the link is as real as gravity. You don’t always see it, but you always feel its pull.
Understanding this connection is one of the most important mindset shifts you can make. It’s the difference between reacting to every headline and calmly holding your course. It’s the difference between speculation and ownership.
Let’s explores why stock prices ultimately follow earnings, how this plays out in real markets, and what it means for your investment strategy.
⚡Key Takeaways
- Earnings are the engine of long‑term stock returns, even when short‑term prices behave irrationally.
- Market sentiment vs fundamentals is a constant tug‑of‑war, but fundamentals win over time.
- The price‑to‑earnings ratio (P/E) helps explain why prices sometimes move faster or slower than earnings.
- Historical data across Europe and the U.S. shows a strong long‑term correlation between earnings growth and stock performance.
What Does It Mean for Stock Prices to Follow Earnings?
Let’s start with the basics. When investors say “stock prices follow earnings,” they mean something very simple:
Over long periods, a company’s share price tends to rise if its earnings rise, and fall if its earnings fall.
This doesn’t mean prices move in a straight line. They don’t. It doesn’t mean earnings are the only thing that matters. They aren’t. And it doesn’t mean every company with rising earnings will be a great investment. Some companies grow earnings but dilute shareholders, take on too much debt, or operate in declining industries.
But as a general principle, across thousands of companies and decades of data:
Earnings growth → stock price growth. Earnings decline → stock price decline.
Why? Because a stock is ultimately a claim on a company’s future profits. If those profits grow, the claim becomes more valuable. If those profits shrink, the claim becomes less valuable.
It’s ownership, not speculation.
Why This Matters for Investors
Most investors—especially beginners—focus on price first. They ask:
- “Is this stock going up?”
- “Is now a good time to buy?”
- “Why is the price falling?”
But price is the effect, not the cause. Earnings most often are the cause.
When you shift your mindset from price‑watching to business‑watching, everything changes. You stop reacting to noise. You start thinking like an owner. And you begin to see the market the way long‑term wealth builders do.
Earnings are real. Earnings are measurable. And earnings compound.
Prices? They’re just opinions—loud ones, and often wrong ones.
The Fundamental Link Between Earnings and Valuation
To understand why stock prices and earnings are so tightly connected, we need to look at valuation. Don’t worry—just the essentials.
The Price-to-Earnings Ratio (P/E)
The P/E ratio is one of the most widely used valuation metrics in investing. It’s a simple bridge beetween price and profit. And it tells you how much investors are willing to pay for €1 of a company’s earnings.
- If a company earns €5 per share and trades at €100, its P/E is 20.
- If it earns €5 per share and trades at €50, its P/E is 10.
But here’s the key insight:
Price = Earnings × P/E
That’s it. That’s the whole relationship.
If earnings rise and the P/E stays the same, price rises. If earnings fall and the P/E stays the same, price falls.
This is why earnings matter so much.
Why P/E Ratios Change
P/E ratios don’t stay constant. They expand and contract based on:
- Growth expectations
- Interest rates
- Risk perception
- Market sentiment
- Competitive dynamics
This is where market sentiment vs fundamentals comes into play. Sentiment affects the P/E ratio. Fundamentals affect earnings.
In the short term, sentiment can dominate. In the long term, fundamentals win.
Historical Evidence: Earnings Growth and Market Returns
Let’s look at what the data shows. Across Europe, the U.S., and global markets, the relationship between earnings and stock prices is remarkably consistent.
1. Long-Term Market Returns Track Earnings Growth
Over the past 50+ years:
- The MSCI Europe Index has grown roughly in line with European corporate earnings.
- The S&P 500 has grown roughly in line with U.S. corporate earnings.
- Global markets show the same pattern.
Short-term deviations? Plenty. Long-term divergence? Almost none.
2. Earnings Explain Most of Long-Term Returns
Academic studies consistently show that:
- Earnings growth + dividends explain the majority of long-term stock returns.
- P/E expansion or contraction explains the rest.
This means that if you want to understand long-term returns, you need to understand earnings.
3. Markets Can Stay Irrational—But Not Forever
There are periods when prices disconnect from earnings:
- The dot‑com bubble
- The 2008 financial crisis
- The 2020 pandemic surge
- The 2022 inflation shock
But in every case, prices eventually realigned with earnings.
This is why long-term investors—especially those with a mindset of patience and prudence—benefit from focusing on fundamentals.
4. Earnings Growth Compounds Like Wealth
If a company grows earnings at 10% per year, earnings double roughly every 7 years. If the P/E stays the same, the stock price doubles too.
This is the quiet, steady power of compounding. It’s not dramatic. But it’s unstoppable.
Short-Term Market Noise vs. Long-Term Fundamentals
But if earnings drive long-term returns, why do stock prices move so wildly in the short term?
The main reason is because markets are human. And humans are emotional creatures.
Short-Term Prices Are Driven by:
- Headlines
- Fear and greed
- Rumors
- Analyst upgrades/downgrades
- Central bank comments
- Political events
- Social media hype
- Algorithmic trading
- Momentum flows
None of these have anything to do with the underlying business.
This is why short-term price movements often feel random. Because they are.
Long-Term Prices Are Driven by:
- Revenue growth
- Profit margins
- Competitive advantages
- Capital allocation
- Innovation
- Cost structure
- Market share
- Management quality
These are the fundamentals. They move slowly. They compound. And they determine the true value of a business.
Everything else is noise.
What This Means for Investors
Here’s some practical takeaways—how you can apply this principle to your own investing.
1. Focus on Earnings, Not Prices
Before buying a stock, ask:
- Are earnings growing over time?
- Are those profits stable, cyclical, or declining?
- Does the company have a clear path to higher earnings in the future?
- Are earnings supported by real demand, not financial engineering?
Price is just the market’s opinion. Earnings are the business reality.
2. Use the P/E Ratio as a Guide—Not a Rule
A low P/E doesn’t mean a stock is cheap. A high P/E doesn’t mean it’s expensive.
Context matters:
- Growth rate
- Risk profile
- Competitive dynamics
- Interest rates
The P/E ratio is one of the simplest ways to understand how the market feels about a company and how much optimism is already priced in.
3. Expect Volatility—But Don’t Fear It
Volatility is normal. It’s the price of admission for long-term returns.
Prices swing because humans swing—between fear and greed, optimism and pessimism, certainty and doubt.
When prices fall but earnings remain strong, that’s often an opportunity.
4. Stay Patient and Let Earnings Compound
Patience is a superpower when it comes to long-term investing. Wealth building is slow. It’s steady. It’s boring. And that’s exactly why it works.
It may feel like nothing is happening for a long time… and then suddenly everything happens all at once.
If you own businesses that grow earnings consistently, the market eventually rewards you—even if the journey is messy.
Conclusion
When you zoom out far enough, the stock market stops looking like chaos and starts looking like a reflection of something much simpler: the steady, compounding growth of real businesses earning real profits.
Understanding that stock prices ultimately follow earnings gives you a kind of inner stillness that many investors never develop. You stop obsessing over daily price moves and start paying attention to long‑term value creation.
👉 Action step: The next time you look up a stock, zoom out and ask yourself “What is the relationship between earnings and the stock price telling you?”