Glossary term
Shiller P/E Ratio (CAPE)
The Shiller P/E ratio, or CAPE, compares a stock index's price with the average of inflation-adjusted earnings over the prior 10 years.
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What Is the Shiller P/E Ratio?
The Shiller P/E ratio, also called CAPE or the cyclically adjusted price-to-earnings ratio, compares a stock index's price with the average of inflation-adjusted earnings over the prior 10 years. It is most often discussed for the U.S. stock market and the S&P 500.
The measure is designed to smooth the earnings cycle. Instead of judging valuation using one year's earnings, CAPE asks how expensive the market is relative to a decade of real earnings power.
Key Takeaways
- CAPE stands for cyclically adjusted price-to-earnings ratio.
- It divides market price by average inflation-adjusted earnings over 10 years.
- It is often used to discuss broad market valuation and long-term expected returns.
- It is less useful for short-term market timing.
How CAPE Is Calculated
A simplified version of the formula is:
Index price is the current level of the market index. Real earnings are earnings adjusted for inflation. The 10-year average is meant to reduce the distortion caused by recessions, booms, and temporary profit swings.
If the index price rises much faster than cyclically adjusted earnings, CAPE rises. If prices fall or long-term real earnings improve, CAPE falls.
How Investors Use It
Investors use CAPE as a long-term valuation gauge. Historically, higher CAPE readings have often been associated with lower future long-term market returns, while lower readings have often been associated with higher future long-term returns. The relationship is not precise, and it does not predict what the market will do next month or next year.
CAPE is most useful as a context measure. It can help frame whether expected returns should be tempered, whether valuation risk is elevated, and whether portfolio assumptions are relying on unusually generous multiples.
Strengths and Weaknesses
Strength | Weakness |
|---|---|
Smooths cyclical earnings swings | Can stay high or low for many years |
Uses a long historical record | Accounting standards and payout policies change over time |
Useful for broad valuation context | Weak short-term timing tool |
Simple to communicate | Not designed for single-stock valuation |
CAPE Versus Regular P/E
A regular P/E ratio usually compares price with one year of earnings, either trailing or forward. CAPE compares price with 10 years of inflation-adjusted earnings. The regular P/E is more current but can be distorted by a single profit slump or boom. CAPE is smoother but slower to respond to structural changes.
Neither measure is complete by itself. Interest rates, inflation, margins, sector mix, tax policy, buybacks, and accounting changes can all affect interpretation.
How to Interpret a High or Low CAPE
A high CAPE does not mean a market crash is imminent. It means investors are paying a high price for long-run real earnings compared with history. That can be justified for a time by low interest rates, strong margins, lower inflation volatility, dominant technology firms, or investor confidence. It can also leave future returns more vulnerable if expectations fall.
A low CAPE does not guarantee an immediate rally. It may reflect recession risk, weak earnings quality, high inflation, political uncertainty, or a distressed market. The signal is strongest when used for long-horizon expectations and weakest when used as a trading trigger.
Portfolio Context
CAPE is most useful at the asset-allocation level. A retirement plan, endowment, or long-term investor may use it to set more realistic return assumptions, stress-test withdrawal rates, or compare broad market valuations across regions. It is less useful for deciding whether to buy or sell a specific company.
The measure should be read with bond yields, profit margins, inflation, cash-flow yields, and diversification needs. Valuation is only one part of expected return.
The Bottom Line
The Shiller P/E ratio is a long-term market valuation measure that smooths earnings across a full decade. It is useful for setting expectations and understanding valuation risk, but it should not be treated as a precise market-timing signal.