Alan Duncan

chacun voit midi à sa porte

2015-08-28

N.B. Each week or so, I try to document the random and not-so-random things that I’ve learned during the week.

Shiller P/E ratio

One of the valuation metrics for equity investing is the price to earnings ratio - the P/E ratio. It is simple to calculate: just divide the stock price by the earnings per share (EPS). But the P/E metric has a number of weaknesses. For example, short-term fluctuations in earnings can drive the P/E ratio unexpectedly high.

To solve this problem, Professor Robert Shiller and economics professor at Yale developed the Shiller P/E or P/E 10 or CAPE (Cyclically adjusted PE ratio). Essentially it smooths out the variations in the earnings cycle by dividing the current price by the inflation-adjusted average of the last 10 years of earnings. Applying that methodology to the entire market via the S&P 500, you can get a more accurate picture of the overall market valuation.

The median for the CAPE is 16.01 and as of market close yesterday, the value stood at 25.22. The metric was at its maximum in December 1999 when it was 44.19 during the dotcom bubble.

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