Cyclically Adjusted Price to Earnings Ratio
The Cyclically Adjusted Price to Earnings Ratio, also known as the Shiller P/E, is a stock valuation measure usually applied to the US S&P 500 equity market. The ratio uses a 10-year moving average of inflation-adjusted earnings to smooth out business cycle fluctuations and provide a more stable measure of fundamental value. The CAPE ratio is a variation of the Price-to-Earnings (P/E) ratio. Similar to the P/E ratio, the CAPE ratio aims to indicate whether a stock is undervalued or overvalued. Financial analysts and economists use the CAPE ratio to assess long-term financial performance, while isolating the impact of economic cycles. The ratio was derived by Robert Shiller, a Nobel Prize-winning economist, and was popularized during the Dotcom Bubble.
ABOUT THE CAPE RATIO
The CAPE ratio allows the assessment of a company’s profitability over different periods of an economic cycle.
The ratio also considers economic fluctuations, including the economy’s expansion and recession.
The CAPE ratio is similar to the price to earnings ratio and is used to determine whether a stock is overvalued or undervalued.
The ratio considers the impact of economic influences by comparing a stock price with average earnings, adjusted for inflation, over a 10-year period.
ROLE IN THE MARKET
In the past, the CAPE ratio has proved its importance in identifying potential bubbles and market crashes.
The historical average of the ratio for the S&P 500 Index is between 15-16, while the highest levels of the ratio have exceeded 30.
The record-high levels occurred three times in the history of the U.S. financial markets.
The first was in 1929 before the Wall Street crash that signaled the start of the Great Depression. The second was in the late 1990s before the Dotcom Crash, and the third came in 2007 before the 2007-2008 Financial Crisis.
CAPE RATIO = Stock price / Average earnings for 10 years adjusted for inflation