ABOUT THE CAPE RATIO
The CAPE Ratio or the Cyclically Adjusted Profit Earnings Ratio, also known as the P/E 10 Ratio or the Shiller Ratio, was developed by Dr. Robert Shiller an Economist from Yale University. Shiller analyzed the S&P 500 Index from 1871 to the current day to determine if a ratio similar in nature to the common P/E ratio but with the added twist of 10 years of Earnings Per Share (EPS) data would be effective and more accurate in determining if the market as a whole was overvalued or undervalued.
What he found was that in general a Shiller P/E Ratio of roughly 20 meant that the market was properly priced as measured against earnings averaged over the previous ten years. The Mean Shiller Ratio value stood at 16.47 while the Median stood at 15.88. The previous ten years are shown here as a summary courtesy of Dr. Shiller's data set which he provides for the public to view.
January 2003 22.89
January 2004 27.65
January 2005 26.58
January 2006 26.46
January 2007 27.2
January 2008 24.01
January 2009 15.17
January 2010 20.52
January 2011 22.97
January 2012 21.21
January 2013 21.9
As one can see the CAPE Ratio was rather high leading into 2008 and might have been an early indicator of the market collapse about to happen later that year. The logic is that the S&P 500 was trading too high and not justified by earnings per share figures as measured by the previous ten years adjusted for inflation (per the CPI index).
Currently as of this date (September 6, 2013) the Shiller Ratio stands at 23.70 while the P/E Ratio as usually measured stands at 18.87.
From a mathematical perspective and for our purposes the CAPE Ratio is calculated as follows:
STOCK PRICE FROM LAST CLOSE
(EPS FOR EACH YEAR FOR PREVIOUS 10 YEARS x INFLATION MULTIPLIER)/10
It is therefore the current price divided by the average earnings per share for the previous ten years adjusted for inflation.
For a very good description of the CAPE Ratio please click here: http://www.pe10ratio.com/
For a really good book on the application of the CAPE Ratio approach towards investing globally see Meb Faber's newest book entitled Global Value: How to Spot Bubbles, Avoid Market Crashes, And Earn Big Returns In The Stock Market
Below is where the CAPE Ratio for the S&P 500 currently stands as of Today:
Image Courtesy of www.multpl.com
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