The P/E 10 ratio—also called the cyclically adjusted price‑to‑earnings (CAPE) ratio or Shiller PE—is a long‑run valuation metric for equity markets. It divides a market’s current price level by the average of inflation‑adjusted (real) earnings per share (EPS) over the prior 10 years. By smoothing earnings over a full business cycle it reduces the influence of temporary booms and busts in corporate profits.
Why it matters
– Long‑run orientation: CAPE is intended to indicate whether broad markets are expensive or cheap relative to history and to help set expectations for long‑term returns (e.g., 10–20 years).
– Historical predictive power: Researchers (notably Campbell & Shiller and Robert Shiller) found that lower CAPE values tend to be associated with higher subsequent long‑term equity returns, and vice versa, though the relationship is noisy.
– Commonly applied to major indexes (e.g., S&P 500). It’s less common for single stocks because company‑specific events can dominate.
How the P/E 10 (CAPE) is calculated — step‑by‑step
1. Choose the index and timeframe. Example: S&P 500 and the past 10 calendar years of reported EPS.
2. Gather nominal annual EPS for each of the last 10 years. (Shiller provides a ready series for the S&P 500.)
3. Convert each year’s EPS to real (inflation‑adjusted) dollars:
• Use a consistent CPI series (e.g., CPI‑U). For each past year: Real EPS_today = EPS_past × (CPI_today / CPI_past).
4. Compute the 10‑year average of those real EPS values.
5. Divide the current price level of the index (or current index value) by that 10‑year average real EPS.
• CAPE = Current price / (Average of last 10 years’ inflation‑adjusted EPS)
Example (illustrative)
– Suppose current index level = 4,000.
– Ten‑year average real EPS = $100.
– CAPE = 4,000 / 100 = 40.
Interpretation
– CAPE above long‑run historical average suggests markets are relatively expensive and expected future long‑run returns may be lower than historical norms.
– CAPE below the historical average suggests cheaper valuations and potentially higher future long‑run returns.
– Shiller’s historical series (1881–Aug 2020) showed a long‑term average near 17.1, with extremes from about 4.8 (Dec 1920) to 44.2 (Dec 1999). These are useful reference points but not definitive “buy”/“sell” signals.
What CAPE can and cannot do
What it can do:
– Offer a smoothed valuation signal that reduces business‑cycle noise.
– Help set realistic long‑term return expectations or guide strategic asset allocation.
– Provide a historical context for current market levels.
Limitations and common criticisms
– Poor short‑term timing: CAPE is not a reliable market‑timing tool—markets can stay expensive (or cheap) for long periods.
– Accounting and structural changes: Changes in accounting rules, corporate tax policy, and the prevalence of share buybacks can affect EPS in ways that make historical comparisons imperfect.
– Interest rates: Lower real interest rates can justify higher CAPE multiples; CAPE doesn’t explicitly incorporate interest‑rate environments.
– Earnings composition: Using an arithmetic mean of 10 years can still be sensitive to very large outliers; some variants use median or trimmed averages.
– International comparability: Different economies and accounting standards complicate cross‑country comparisons.
– Example of limits in practice: In July 2011 CAPE suggested the S&P 500 was significantly overvalued compared with long‑run averages, yet the index rose more than 35% by November 2013 (see AAII critique).
Practical steps for investors (how to use CAPE responsibly)
1. Use CAPE as one input, not a sole decision driver.
• Combine valuation measures (CAPE, trailing P/E, forward P/E, price‑to‑book, dividend yields) and macro indicators.
2. Set long‑run return assumptions using CAPE‑informed scenarios.
• If CAPE is materially above historical averages, expect lower average real returns over the next decade versus periods when CAPE was low.
3. Calibrate asset allocation, not timing.
• Consider modestly lowering equity allocation when CAPE is extreme and raising exposure when CAPE is unusually low—do so gradually and with risk controls.
4. Use valuation‑aware dollar‑cost averaging.
• Reduce risk of mistimed lump‑sum buys by spreading purchases over time when valuations are high.
5. Incorporate yield and interest‑rate context.
• Compare equity CAPE to yields on long‑term government bonds; lower bond yields can justify somewhat higher CAPE.
6. Adjust retirement withdrawal and liability planning.
• Use CAPE‑adjusted expected returns to stress‑test retirement withdrawal rates and sequence‑of‑returns risk.
7. Consider CAPE variants and adjustments.
• Look at CAPE using median earnings, excluding one‑offs, or using operating earnings; examine real rates and profit margins for additional context.
8. Keep a long time horizon and diversified portfolio.
• CAPE is most relevant for multi‑year planning. Maintain diversification across asset classes, geographies, and factors.
How you can calculate CAPE yourself (practical guide)
1. Get data:
• Price/index level for the current date (e.g., S&P 500 close).
• Annual EPS for the index for the last 10 years (Shiller’s dataset provides S&P EPS series).
• CPI series (BLS CPI‑U or similar).
2. In a spreadsheet:
• For each of the 10 past years, compute: Real EPS = EPS_year × (CPI_today / CPI_year).
• Compute the arithmetic mean of the 10 real EPS figures.
• Divide current price by that mean to get CAPE.
3. Or use published CAPE series:
• Robert Shiller publishes the CAPE series for the S&P 500, updated regularly (simplifies the calculation).
Further reading and data sources
– Investopedia, “P/E 10 Ratio” (overview and examples):
– Robert J. Shiller, “Online data: U.S. Stock Markets 1871–Present and CAPE Ratio” (data series):
– Campbell, John Y., and Robert J. Shiller. “Stock Prices, Earnings, and Expected Dividends.” The Journal of Finance, vol. 43, no. 3, 1987, p. 664.
– American Association of Individual Investors, “A Cautionary Note about Robert Shiller’s CAPE” (Sept. 2011).
– Macrotrends, S&P 500 historical charts and data: / (for long‑run index charts).
– Benjamin Graham & David Dodd, Security Analysis (1934) — the multi‑year earnings smoothing idea originated here.
Bottom line
The P/E 10 (CAPE) ratio is a robust tool for assessing long‑term valuation of broad equity markets because it smooths cyclical earnings swings. It provides useful context for return expectations and strategic allocation decisions, but it’s imperfect: it should be used alongside other valuation metrics, macro variables (especially interest rates), and prudent portfolio construction practices rather than as a short‑term trading signal.