Over the past decade, the S&P 500 has surged a whopping 200%, allowing for the question to be raised. Are valuations too high?
The Shiller PE, also known as the Cyclically Adjusted Price-to-Earnings Ratio (CAPE Ratio), is a valuation ratio. It is derived from the more common Price-to-Earnings Ratio (P/E Ratio) which measures a stock’s price relative to the company’s earnings per share.
Popularized by Yale University professor Robert Shiller, the Shiller PE aims to give investors a clearer picture by widening the frame of analysis from 1 (the P/E ratio) to 10 years. Therefore, the Shiller PE considers economic cycles (i.e., expansion and recession) in its calculation, allowing for near-term changes that have little to do with companies’ fundamentals, to be mitigated. In other words, the Shiller PE assesses long-term financial performance, by isolating the impact of economic cycles while also, adjusting earnings for inflation.
The formula above shows us how the Shiller PE ratio is calculated. An increase in an asset’s stock price or a period of relatively poor earnings will lead to a higher Shiller valuation of the underlying asset.
This ratio can be computed for specific stocks and sectors, but it is more commonly used to look at a broader stock index. In the case of the S&P 500 Index, as we can see from the chart above, the historic average sits at around 17x. Such levels pale in comparison to those we are currently experiencing. The Shiller PE currently sits at approximately 34, creeping ever closer to the historic highs of the 2000s dot-com bubble.
