Shiller CAPE Ratio
The Shiller P/E Ratio (Cyclically Adjusted Price-to-Earnings Ratio, CAPE), also known as the cyclically adjusted earnings ratio, was proposed by Nobel Prize-winning economist Robert Shiller in 1998. It is calculated by dividing the actual stock price adjusted for inflation by the average of the company’s inflation-adjusted earnings per share over a ten-year period.
The Shiller P/E Ratio primarily aims to provide a market valuation indicator adjusted for economic cycle fluctuations. It measures market valuation by comparing the market price to the average actual earnings over the past ten years. Compared to traditional P/E ratios, the Shiller P/E Ratio better reflects long-term market trends and reduces the impact of short-term fluctuations on valuation results.
Buffett Indicator
In “Buffett’s most important original book “Tap Dancing to Work”” I quoted Buffett’s own views on the Buffett Ratio: If the market capitalization of all publicly traded companies relative to national GDP falls to 70% or 80%, buying stocks will yield significant profits. If it approaches 200%, as in 1999 and 2000, or nearly 220% in 2021, buying stocks is a recipe for disaster.
The Buffett Indicator is currently around 220%, a record high.
Buffett has said that this indicator is “perhaps the best single measure of valuation at any given moment.”
The Buffett Indicator has averaged 0.95 since 1970. In the past, a Buffett Indicator exceeding 100% was considered overvalued. During the dot-com bubble in 2020, it was around 170%. Recently, however, values exceeding 150% have become the norm. Buffett reportedly said during the dot-com bubble around 2000 that “this should be a very strong warning sign.” Please refer to the explanation in my post of “Powerful and persuasive Buffett indicator, whether market is overheat“
In the past, values exceeding 100% were considered overvalued, but recently, US indices exceeding 150% have become the norm.
But please note: The Buffett Indicator reflects Buffett’s belief that, over the long term, corporate revenue (and therefore stock market capitalization) cannot grow much faster than the economy itself. He didn’t invent this indicator for stock trading; it’s more of a macro metric, a way for him to gauge whether the overall market is cheap or expensive.
Why is Shiller CAPE more popular?
The main argument of skeptics who criticize the Buffett Indicator as inaccurate is that overseas operations account for an increasingly significant portion of U.S. corporate revenue and earnings. The larger the company, the higher the proportion of overseas revenue. Therefore, given today’s heavy reliance on overseas revenue, the Buffett Indicator, calculated based on a country’s gross domestic product (GDP), may be less accurate—which is why most people prefer the Shiller CAPE ratio.
Overall, in 2024, 28% of revenue for companies in the S&P 500 index will be derived from overseas, while the Russell 2000 index, which includes many smaller companies, will have a 20% share. If we only look at the seven largest US stock companies that have been the primary drivers of market capitalization growth over the past few years, these companies derive approximately half of their revenue from overseas.
Dividing the current US stock market capitalization of $65.47 trillion by the US GDP of $30.15 trillion yields a current Buffett indicator of 217%. Subtracting $10 trillion from the market capitalization to reflect the fact that half of the revenue of the seven largest US stock companies comes from overseas, the Buffett Indicator drops to 183%. If all information technology stocks are included, the Buffett Indicator drops even further.
Current CAPE ratio
The current CAPE ratio has reached the 98th percentile of nearly 150 years of historical data. The Shiller CAPE, calculated based on the 10-year inflation-adjusted price-to-earnings ratio of stocks, is currently 39.92, approaching the 40x mark.
The last time the Shiller CAPE exceeded 40 was during the dot-com bubble burst, which was also the first time the index had exceeded 40x. Prior to that, the Shiller CAPE had never exceeded 30x, with the exception of the period just before the Great Recession. In other words, the Shiller CAPE is now higher than during the Great Depression and is approaching the level during the dot-com bubble burst. For more details, please see my other post, “Comparing US and Taiwan Stock Market Valuations: Both Are Currently at All-Time Highs.”
Related articles
- “Indicators helps to interpret the direction of stock market and economic climate“
- “Fedex directly linked to economic prosperity, how does Fedex make money? why it’s downward? “
- “Powerful and persuasive Buffett indicator, whether market is overheat“
- “Irrational Exuberance Indicator“
- “Buffett’s most important original book “Tap Dancing to Work”“
- “Why market fall after Q2 2004 earning report?“
- “Sahm Rule, a 100% accurate recession indicator, was triggered“
- “Buffett’s most important original book “Tap Dancing to Work“
- “The relationship between GDP and stock prices“
- “Tax, inflation and rate are the top three serious killers to investors“
- “US Gross domestic product (GDP) querier“
- “Simple and compound interest calculator“
- “IRR Calculator“
- “Investors should care annualized rate of return (IRR), calculate with free IRR Calculator“
- “Identify good companies with corporate culture, how to do in overheated market?“
Disclaimer
- The content of this site is the author’s personal opinions and is for reference only. I am not responsible for the correctness, opinions, and immediacy of the content and information of the article. Readers must make their own judgments.
- I shall not be liable for any damages or other legal liabilities for the direct or indirect losses caused by the readers’ direct or indirect reliance on and reference to the information on this site, or all the responsibilities arising therefrom, as a result of any investment behavior.
