CAPE Ratio (Shiller P/E): Definition, Calculation, and Market Insights

What is the CAPE ratio?

The CAPE ratio—cyclically adjusted price-to-earnings ratio—is a valuation measure that divides a market’s current price by the inflation-adjusted average of earnings over the previous 10 years. Popularized by economist Robert Shiller, it smooths short-term profit swings to give a longer-term view of whether broad equity markets appear overvalued or undervalued.

How to calculate

CAPE = Share price / (10‑year average of inflation‑adjusted real earnings per share)

Key points:
* Earnings are averaged over 10 years to reduce the impact of business-cycle extremes.
* Earnings are adjusted for inflation so comparisons across time reflect real purchasing power.

What the CAPE ratio tells you

• Cyclical smoothing: By averaging real earnings over a decade, CAPE reduces the distortion caused by recessions or booms that temporarily push earnings down or up.
• Valuation signal: High CAPE values (relative to historical norms) suggest markets may be expensive and future long-term returns could be lower; low CAPE values suggest cheaper valuations and potentially higher returns.
• Not a short-term timing tool: CAPE is intended for long-horizon analysis and is not a precise indicator for market timing over months.

Real-world context

Robert Shiller and John Campbell brought widespread attention to the method in the 1990s when they showed stock prices had risen faster than underlying earnings. Historical peaks in CAPE have coincided with major market corrections (for example, the late-1920s, the dot-com era, and the housing/financial crisis period), which fueled debate about its predictive usefulness. Over long spans, CAPE has often signaled periods of elevated valuation relative to its long-term average (roughly mid-teens for the U.S. market).

Limitations and criticisms

• Backward-looking: CAPE relies on past earnings and may not reflect structural changes in the economy or corporate profitability going forward.
• Accounting changes: CAPE typically uses GAAP earnings, and changes in accounting rules or reporting practices can affect comparability across periods.
• Sector composition and buybacks: Shifts in sector weights (e.g., growth of technology) and corporate actions (like stock buybacks) can alter index earnings dynamics and influence CAPE readings.
• Alternative earnings measures: Some researchers argue that using consistent measures such as operating earnings or national-accounting profits can improve predictive power relative to GAAP-based CAPE.

Practical guidance for investors

• Use CAPE as a broad, long-term valuation signal rather than a short-term trading indicator.
• Combine CAPE with other metrics (economic indicators, yield curves, sector valuation, company fundamentals) to form a fuller view.
• Consider the context: structural changes in accounting, tax policy, corporate behavior, and the macroeconomy can affect how CAPE should be interpreted.

Quick FAQs

• What does CAPE stand for?
  Cyclically Adjusted Price-to-Earnings.

• Is CAPE the same as the regular P/E ratio?
  No. The regular P/E uses a single year’s earnings (often trailing 12 months), while CAPE uses a 10-year inflation‑adjusted average to smooth cycles.

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• Can CAPE predict immediate market moves?
  No. It is better suited to long-term (multi-year to decade) return expectations, not short-term market timing.

Bottom line

The CAPE ratio is a useful tool for assessing long-term market valuation by smoothing cyclical earnings volatility. It has signaled extended overvaluation and under-valuation historically, but it is imperfect—particularly because it is backward-looking and sensitive to accounting and structural changes. Treat CAPE as one component of a broader valuation and risk assessment framework.