A sibling of the P/E ratio, the Cyclically Adjusted Price Earnings (CAPE) ratio is a variation that uses the ten-year average of inflation-adjusted earnings instead of single year earnings. Ivy League professor Dr. Robert J. Shiller built upon earlier work and popularized the CAPE ratio–or Shiller P/E–in Irrational Exuberance, a book published near the peak of the Dot-Com Bubble in 2000.
Dr. Shiller’s calculation considers a ten-year average of earnings per share to avoid noisy gyrations and pairs that with the current price. The academic analysis associated high CAPE ratios (when the market is purportedly expensive) with relatively poor future returns, while low CAPE ratios (when the market is purportedly inexpensive) were associated with higher future returns.
CAPE Ratio in Detail
In our May 2023 Insight, we offer additional detail on the CAPE’s calculation, discuss the current reading and offers a series of charts that explain why we think a single figure should not cause panic (even if the pundits on television and in print use it to drum up a frenzy).
We can appreciate the simplicity of a single data point, but there’s little evidence the CAPE ratio works to inform trading strategies. If anything, the report shows that stocks historically rise over longer periods of time, meaning a gain five or ten years down the road was the most probable outcome anyway, irrespective of the ratio’s latest reading.
A Robust Framework for Success
Market gyrations often serve as reminders of the value offered by a robust framework, which we believe is a critical part of the toolkit needed to achieve sustainable wealth generation and financial success. Our experienced team of Wealth Advisors at The Prudent Speculator would love to help you achieve your goals Wealth Management – The Prudent Speculator.
Kovitz Investment Group Partners, LLC (“Kovitz”) is an investment adviser registered with the Securities and Exchange Commission. This report should only be considered as a tool in any investment decision and should not be used by itself to make investment decisions. Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this publication are considered reliably sourced, but no representation is made that it is accurate or complete and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Past performance is not indicative of future results, which may vary.