Cyclically Adjusted Price-to-Earnings (CAPE) Ratio

The Cyclically Adjusted Price-to-Earnings (CAPE) ratio is a valuation measure that adjusts the traditional P/E ratio by using average inflation-adjusted earnings over a 10-year period. This helps smooth out fluctuations in profits caused by economic cycles and provides a more accurate long-term view of a company's or market's value. The CAPE ratio is often used by investors to assess whether a market is overvalued or undervalued.

Example

If the CAPE ratio for the S&P 500 is significantly higher than its historical average, it may suggest that the stock market is overvalued and could be due for a correction.

Key points

• The CAPE ratio adjusts the P/E ratio by using average earnings over a 10-year period.

• It smooths out earnings fluctuations due to economic cycles, providing a more accurate long-term valuation.

• The CAPE ratio is commonly used to assess whether markets are overvalued or undervalued.

Quick Answers to Curious Questions

What is the CAPE ratio?

The CAPE ratio is a valuation measure that adjusts the traditional P/E ratio by averaging inflation-adjusted earnings over a 10-year period to provide a longer-term view of value.

How does the CAPE ratio differ from the regular P/E ratio?

While the regular P/E ratio uses current earnings, the CAPE ratio uses average earnings over a decade to smooth out short-term fluctuations and provide a more stable measure of valuation.

Why do investors use the CAPE ratio?

Investors use the CAPE ratio to assess whether a stock or market is overvalued or undervalued, providing a long-term perspective on potential investment opportunities.