How To Use The CAPE Ratio To Double The Return Of The S&P 500

But it wasn’t until 1996 that Yale University professor Robert Shiller and his colleague John Campbell proposed the CAPE ratio. If you want to get rich you cannot just haphazardly throw darts at the stock page. You must have a plan and demonstrably useful tools to limit risk while also enhancing your returns. The CAPE ratio is one of the tools I use to help me beat the market averages. The CAPE ratio is not a 100% set and forget tool and it is not a market timing tool. However it has demonstrated itself as a fairly accurate tool that can be used as a starting point in identifying historically cheap markets which can then be researched further for opportunities.

This means it can take into account longer-term business cycles and smooth out short-term market movements and volatility. The data format and delivery method can be individually customized based on your requirements. The CAPE ratio was first given attention when Robert Shiller and John Campbell presented research to the Federal Reserve in 1996, suggesting that the U.S.’s stock prices were increasing much faster than earning. In their 1998 article, “Valuation Ratios and the Long-Run Stock Market Outlook,” Shiller and Campbell looked at earnings for the S&P 500 using the CAPE ratio of the past 10 years, going back to 1872. From their findings, the ratio was at a record 28 in January 1997, with the only other comparably high ratio occurring in 1929.

  1. And while looking back isn’t always the best solution for making forward-looking predictions, the CAPE ratio provides aggregate data that’s an effective means to benchmarking a company’s value.
  2. And the higher the value of the ratio, the less likely equities are to achieve oversized returns, as their stock prices are inflated already.
  3. EPS can be regarded as the profit of the company that gets divided by the equity shares that are outstanding.
  4. Discover the range of markets and learn how they work – with IG Academy’s online course.

First and foremost, this is not meant as a research paper; but rather, as an article that might help the potential investor develop better asset allocation strategies. Most investors and groups I have spoken with have utilized this as simply another metric in an already large repertoire of tools to do their fundamental analysis. It is probably best to utilize the CAPE Ratio in that manner instead of relying strictly on the CAPE Ratio as the only method for developing a portfolio. About a year ago I started a site called which was devoted to the exploration of the CAPE Ratio (Cyclically Adjusted P/E Ratio) as a method to find deep value plays within the market. The site was the first to offer the user the ability to find the CAPE Ratio for an individual stock instead of simply finding the CAPE for the entire S&P 500. The usefulness of this approach was based on the assumption that there might be hidden pockets of value on an individual stock basis.

How Can You Use the Shiller P/E Ratio

It was named after professor Robert Shiller who first developed the method, alongside his colleague John Young Campbell. The two suggested ten-year earnings were strongly correlated with returns for the next 20 years. The current level shows an over-extension of over 100% from the last 20-year historical average, which had always resulted in abrupt market crashes.

Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. When evaluating the stock market, it’s always important to consider a variety of factors, not just one metric. Always consult with a financial advisor before making any major investment decisions.

Limitations of the CAPE Ratio

Open an account with us and be ready to deal on live markets in minutes. In the same way as the P/E ratio, a stock with a high CAPE ratio is considered overvalued, and a stock with a low CAPE ratio would said to be undervalued. The Shiller P/E ratio is a reliable measure of valuation when compared against the historic P/E ranges and averages of the same stock, as well as when compared to its industry, index, and close competitors. However, the king of extremely high P/E ratios during bull cycles is the NASDAQ 100, which has an average P/E of 29.1, which is over 50% bigger than the DOW Industrial index. If the P/E ratio of stock ranges close to each of those four averages, it may be considered fairly valued.

CAPE Ratio Disadvantages

In June 2018, the CAPE ratio was 33.78, significantly higher than its long-term average of 16.80, only the second time the ratio exceeded 30, the other being in 1929. This sparked a debate about whether or not the ratio portends a significant market correction. But it’s important to remember that the CAPE ratio is not a perfect predictor of future stock market returns. The table below lists the historical and current CAPE ratios of the largest equity markets in the world. Among the largest economies, the most expensive stock markets can be found from India, the U.S. and Japan.

Based solely on the CAPE ratio, the most expensive stock markets (among the 25 largest economies measured by GDP) can be found from India, United States and Japan. The Indian stock market has been trading at high multiples for many years but the nation’s equities just refuse to correct but keep reaching for higher levels. The high CAPE ratio of Japan is explained by the strong performance of the country’s stock market during the recent years and strong earning of the Japanese stock market. Unlike the traditional price to earnings ratio (P/E), the CAPE ratio attempts to eliminate fluctuations that can skew corporate earnings, i.e. “smoothen” the reported earnings of companies.

This makes it a more reliable measure of market valuation than the conventional price-earnings ratio. Generally, relying on one-year earnings doesn’t accurately predict long-term company financial performance. As a result, John Y. Campbell and Robert Shiller stated that future earnings could be expected using a long-term moving average of actual profits. (The CAPE ratio is even more predictive of furious debate about its accuracy). is a global comparison service simplifying your choices when you need to borrow or save money. We compare personal finance solutions such as loans, saving accounts, credit cards, and more. While the ratio has a fair amount of drawbacks, it is an essential tool in the arsenal of a strategic free forex signals investor. There are several issues with using the Shiller P/E ratio as a standalone valuation metric. The highest ever average P/E ratio for the S&P 500  was 44.19, recorded on Dec 1999, right before the .com bubble crash. Today, the P/E is dangerously close to the same levels, close to 40.

Now, post computing the CAPE ratio (as explained in the earlier example), the CAPE ratio for the index stands at 34. As Volatility in the EPS values also leads to P/E (Price-Earnings) ratio for bouncing significantly, the experts recommend that one should prefer using the average of earnings for a period of around 7 or 8 years. The S&P 500 fell a notable 2% on Thursday and closed out Friday even lower. The CAPE Ratio as explored by Robert Shiller would seem to indicate that the market is overvalued. Prior to Thursday the CAPE for the entire S&P 500 was around 26.50 and now it is around 25.50 (still much higher than where the safe zone is considered to be for CAPE).

Many investors use P/E as a quick metric for understanding relative value; however, the CAPE ratio might be a more accurate way to gauge whether a stock is over- or under-valued. And while looking back isn’t always the best solution for making forward-looking predictions, the CAPE ratio provides aggregate data that’s an effective means to benchmarking a company’s value. The chief problem with a standard P/E calculation is that it doesn’t account for the economic cycle. And P/E only offers a snapshot into the forward-looking financial health of the company. If EPS rises or falls while the stock’s price remains the same, it’s more of an economic indicator as opposed to a barometer for company performance. Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.

In addition, some world crises force the government to devise rules to maintain business activities, minimizing the negative impact on the environment and society. Assuming the dividend rate stays the same, an increase in the market value of the shares causes the dividend yield to decrease, whereas a decrease in the stock’s market value causes the dividend yield to rise. You can adapt those bands to suit your favourite average from our CAPE ratio by country table.

S&P 500 Shiller CAPE Ratio (I:SP500CAP)

However, the CAPE ratios of different markets should not be directly compared to each other. The best way to evaluate if a country’s stock market might be undervalued or overvalued is to compare the nation’s current ratio to its historical average. The CAPE Ratio (also known as the Shiller P/E or PE 10 Ratio) is an acronym for the Cyclically-Adjusted Price-to-Earnings Ratio. The ratio is calculated by dividing a company’s stock price by the average of the company’s earnings for the last ten years, adjusted for inflation.






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