The PE or Price-to-Earnings ratio divides a company’s stock price by the earnings reported by that company. The CAPE Ratio is a variant of this measure developed by Yale economist Robert Shiller and is typically applied to indices like the S&P500. The Cyclically Adjusted Price Earnings ratio divides the past 10 years’ average inflation-adjusted earnings by the current stock index value. The CAPE Ratio smooths out the impact of business cycles and other events and gives a better picture of a market’s sustainable earning power. Shiller found that the lower the CAPE Ratio, the larger the expected return over the next 20 years. It is criticized for being too pessimistic, and for undervaluing the earnings growth of new companies.
