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Shiller PE Ratio: Briefly about the main

Cyclically Adjusted Price-to-Earnings ratio, CAPE

DEFINITION:

Shiller P/E Ratio (also known as the Shiller P/E or PE 10 Ratio, CAPE Ratio or Cyclically Adjusted Price-to-Earnings ratio):

  • investment valuation metric that measures a stock's price relative to the company's earnings per share (EPS);
  • is the metric commonly used to measure equity market valuations in overall, most often applied to the US S&P 500;
  • nevertheless, also applied to individual companies, and can be used to analyze individual stocks, exchange-traded funds (ETFs), and other assets;
  • helps to understand whether stocks are overvalued, undervalued or fairly-valued, i.e., whether stocks are pricey, cheap or they are traded with a fair price;
  • removes the short-term volatility in earnings;
  • minimizes the impact of short-term changes in a company’s earnings performance (market correction, economy’s expansion and recession, economic bubbles etc.);
  • gives a better overview of a company's sustainable long-term earning power;
  • is backward-looking ratio, based on historical data.

In order to understand better the Shiller P/E ratio you first need to study the P/E ratio (Price-to-earnings ratio). The core idea and difference of Shiller PE Ratio is that the earnings of the past 10 years are inflation-adjusted and averaged. E10 concept, used for P/E calculation, was derived by Robert Shiller, an American economist, Yale University professor and Nobel Prize Laureate in economics.

FORMULAS for calculations:

Shiller PE Ratio (CAPE) = Current Share Price / E10

WHERE: E10 - the average of the inflation adjusted earnings (Adjusted EPS) of a company over the past 10 years.


Adjusted EPS = Earnings per Share / CPI Change * Current CPI

WHERE: CPI - Consumer Price Index, CPI data of the country/region where the company is headquartered typically has used.

E10 = [ ∑10i=1 Adjusted EPSi ] / 10

In order to get the E10, calculate Adjusted EPS for each year of 10-year period using the consumer price index (CPI), then add all the results together and divide 10.

RESULT INTERPRETATION:

Shiller PE ratio for the S&P 500:

  • varies over time, as of January 2022, the average P/E 10 was 17.3 over a period of more than 100 years (ONLINE DATA ROBERT SHILLER);
  • the values higher than the average P/E 10 implying lower long-term annual average returns;
  • if P/E 10 ratio is much more than the average it indicates that the market is overvalued; too high Shiller P/E could be an indicator of a market correction, high ratio values can be associated with impending market crashes and potential bubbles;
  • the lower the ratio, the higher the investors' likely annual average returns over the long run.

Shiller PE ratio for stocks:

  • high P/E ratios signify a company may be overvalued: the higher the ratio, the more overvalued a market (company stock);
  • the low P/E indicates that the stock may be undervalued and, as a result, it may be a good value buy with the high future returns potentially;
  • works better for cyclical companies.

FIND MORE:
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