Schiller Pe Calculation Example

Calculate the Cyclically Adjusted Price-to-Earnings (CAPE) Ratio using Robert Shiller’s methodology to evaluate market valuation relative to historical earnings.

Comprehensive Guide to Schiller PE Ratio Calculation

The Schiller PE Ratio, also known as the Cyclically Adjusted Price-to-Earnings (CAPE) ratio, is a valuation metric developed by Nobel laureate Robert Shiller. Unlike the traditional P/E ratio which uses only the most recent 12 months of earnings, the CAPE ratio uses real (inflation-adjusted) earnings over a 10-year period to smooth out short-term fluctuations and provide a more accurate picture of market valuation.

Why the Schiller PE Ratio Matters

The standard P/E ratio can be misleading during economic cycles because:

• Earnings are highly volatile over short periods
• Business cycles can temporarily inflate or deflate earnings
• Accounting changes can distort single-year earnings
• Inflation erodes the real value of earnings over time

The CAPE ratio addresses these issues by:

1. Using a 10-year average of earnings (adjustable in our calculator)
2. Adjusting for inflation to show real earnings power
3. Providing a smoother, more stable valuation metric
4. Offering better predictive power for long-term returns

Historical Context and Interpretation

Robert Shiller’s research shows that the CAPE ratio has significant predictive power for future stock market returns. Historical data from the S&P 500 (1871-present) reveals these key benchmarks:

CAPE Ratio Range	Historical Frequency	Subsequent 10-Year Real Return	Market Valuation Implication
< 10	12% of months	10.3% annualized	Significantly undervalued
10-15	25% of months	8.7% annualized	Moderately undervalued
15-20	28% of months	6.8% annualized	Fairly valued
20-25	20% of months	4.2% annualized	Moderately overvalued
> 25	15% of months	0.5% annualized	Significantly overvalued

Source: Robert Shiller’s Online Data (Yale University)

How to Calculate the Schiller PE Ratio

The formula for the CAPE ratio is:

CAPE Ratio = (Price) / (10-Year Average of Inflation-Adjusted Earnings)
        

Our calculator performs these steps automatically:

1. Inflation Adjustment: Each year’s earnings are adjusted for inflation using the formula:
   Adjusted Earnings = Nominal Earnings / (1 + Inflation Rate)^Years Ago
2. Earnings Averaging: The inflation-adjusted earnings are averaged over the selected period (standard is 10 years)
3. Ratio Calculation: The current price is divided by this average to get the CAPE ratio
4. Valuation Assessment: The result is compared against historical benchmarks

Practical Applications of the CAPE Ratio

Investors and analysts use the CAPE ratio for:

• Market Timing: Identifying periods when markets are historically over/undervalued
• Asset Allocation: Adjusting equity exposure based on valuation levels
• Long-Term Planning: Setting return expectations for retirement planning
• International Comparisons: Comparing valuations across different markets
• Sector Analysis: Applying the methodology to specific industries

Academic Research on CAPE Ratio

The CAPE ratio’s predictive power has been extensively studied:

• NBER Working Paper 19201 (2013) – “Predictive Regressions with Time-Varying Coefficients”
• Federal Reserve Study (2018) – “The CAPE Ratio and Stock Market Returns”
• Social Security Administration Research (2010) – “Valuation Ratios and Long-Horizon Stock Returns”

Limitations and Criticisms

While powerful, the CAPE ratio has some limitations:

1. Accounting Changes: GAAP changes over time can affect earnings comparability
2. Structural Economic Shifts: Changes in dividend payout ratios or share buybacks
3. Interest Rate Environment: Low rates may justify higher valuations
4. Sector Composition: Tech-heavy markets may have different “normal” ratios
5. Globalization Effects: Multinational earnings may not reflect domestic inflation

Some critics argue that:

“The CAPE ratio’s predictive power has diminished in recent decades due to structural changes in the economy, particularly the rise of intangible assets and the technology sector which command higher valuations.”

Alternative Valuation Metrics

Investors often use the CAPE ratio alongside other metrics:

Metric	Formula	Advantages	Limitations
Price-to-Book (P/B)	Price / Book Value per Share	Good for asset-heavy companies Less affected by accounting changes	Poor for service/tech companies Book value can be misleading
Price-to-Sales (P/S)	Price / Revenue per Share	Harder to manipulate than earnings Useful for growth companies	Ignores profitability Varies significantly by industry
Dividend Yield	Annual Dividend / Price	Simple to calculate Directly measures income	Not applicable to non-dividend stocks Can be misleading if dividend isn’t sustainable
Enterprise Value/EBITDA	EV / EBITDA	Considers debt and cash Focuses on operating performance	EBITDA ignores capital expenditures Can overstate cash flow

Applying the CAPE Ratio to Your Investments

Practical ways to use the CAPE ratio:

1. Strategic Asset Allocation:
   • CAPE > 25: Consider reducing equity exposure
   • CAPE 15-25: Maintain normal allocation
   • CAPE < 15: Consider increasing equity exposure
2. Tactical Adjustments:
   • High CAPE: Shift to value stocks or international markets
   • Low CAPE: Increase exposure to growth stocks
3. Return Expectations:
   • Use historical return data to set realistic expectations
   • Adjust withdrawal rates in retirement planning
4. Sector Rotation:
   • Calculate sector-specific CAPE ratios
   • Rotate into undervalued sectors

Common Mistakes to Avoid

When using the CAPE ratio, beware of these pitfalls:

• Over-relying on a single metric: Always use CAPE alongside other indicators
• Ignoring the interest rate environment: Low rates can justify higher valuations
• Assuming mean reversion is immediate: Markets can remain over/undervalued for years
• Not adjusting for structural changes: Today’s economy differs from the 1870s
• Using nominal instead of real earnings: Inflation adjustment is crucial
• Applying it to individual stocks: CAPE works best for broad indices

Advanced Applications of the CAPE Ratio

International CAPE Comparisons

The CAPE ratio can be calculated for international markets, though data availability varies. Research from StarCapital shows significant variations:

Country/Region	CAPE Ratio (2023)	10-Year Avg CAPE	% Undervaluation/Overvaluation
United States (S&P 500)	30.1	16.9	+78%
Europe (Stoxx 600)	18.4	15.2	+21%
Japan (Topix)	22.3	20.1	+11%
Emerging Markets	15.8	14.7	+7%
United Kingdom (FTSE 100)	14.2	13.8	+3%

Source: StarCapital Research, 2023

Sector-Specific CAPE Analysis

Applying CAPE methodology to sectors reveals interesting patterns. For example, technology sectors typically have higher “normal” CAPE ratios due to:

• Higher growth expectations
• Lower capital intensity
• Network effects and winner-take-all dynamics
• Intangible assets not captured in book value

Conversely, utilities and financials tend to have lower CAPE ratios because:

• More stable, predictable earnings
• Higher capital requirements
• Regulatory constraints on growth
• More tangible asset base

CAPE Ratio and Business Cycles

The CAPE ratio tends to move counter-cyclically:

• Early Expansion: CAPE often rises as earnings recover from recession lows
• Mid Expansion: CAPE stabilizes as earnings growth matches price appreciation
• Late Expansion: CAPE often peaks as optimism drives prices beyond earnings growth
• Recession: CAPE drops sharply as earnings fall faster than prices

Research from the Federal Reserve shows that the CAPE ratio’s predictive power is strongest when:

1. Calculated over full business cycles (peak-to-peak or trough-to-trough)
2. Combined with other valuation metrics
3. Used with a 5-10 year investment horizon
4. Adjusted for structural breaks in the economy

Conclusion: Integrating CAPE into Your Investment Process

The Schiller PE ratio remains one of the most robust valuation metrics available to investors. While no single indicator should drive investment decisions, the CAPE ratio provides valuable context about:

• Long-term return expectations
• Relative valuation across markets
• Potential risks in overheated markets
• Opportunities in undervalued sectors

For best results:

1. Use the CAPE ratio as one input among many in your analysis
2. Combine with other fundamental and technical indicators
3. Consider the current interest rate environment
4. Adjust for structural changes in the economy
5. Maintain a long-term perspective (5+ years)
6. Regularly rebalance based on valuation signals

By understanding and properly applying the Schiller PE ratio, investors can make more informed decisions about asset allocation, risk management, and return expectations across different market environments.