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"The Cyclically Adjusted Price to Earnings Ratio, also known as CAPE or the Shiller PE Ratio, is a measurement from Robert Shiller. It adjusts past company earnings by inflation to present a snapshot of stock market affordability at a given point in time."

https://dqydj.com/shiller-pe-cape-ratio-calculator...

Pointless, interesting, or what?

S&P500 CAPE is currently about 33. Interesting to me, it was also about 33 in January 1998, when I bought my first shares of Berkshire.

Berkshire performed significantly better than S&P500 since then. CAPE was also about 33 in June 2001, with the same result.

15 years ago, the S&P500 CAPE was 16, and S&P500 performed better than Berkshire since then.

Only three data points, of course, but could it be that relative valuation matters over the long term?

[Posted something similar (with pictures!) on the Fool]

Is there anyplace where you can plot CAPE vs a single stock ?

Thanks
Rich

Is there anyplace where you can plot CAPE vs a single stock ?

You probably won't get the result you hope for.

The reason that CAPE has such strong predictive power for forward returns over a multi-year horizon is that the value of the companies a very broad index in a very broad economy can grow in value only as fast as that economy, which is a relatively small and predictable rate. That same reasoning does not work for a single company, which can have sudden changes for the better or for the worse.

There are a few companies with unusually steady economic progress, showing up as pretty steady progress in real earnings per share. A long term chart of their P/E ratios can give you a pretty good idea of the current valuation level. Stockcharts.com is one I use, as you get get charts with rolling EPS and rolling P/E ratios. But even with those you have to understand the business well enough to have an idea of the likelihood of the trajectory continuing into the future a somewhat similar way.

Jim

Jim: The reason that CAPE has such strong predictive power for forward returns over a multi-year horizon is that the value of the companies a very broad index in a very broad economy can grow in value only as fast as that economy, which is a relatively small and predictable rate.

Does CAPE have strong predictive power?
I notice that over the last 10 years:
SPY (and Berkshire) CAGR 8.7% real
GDP CAGR 2.3% real
CAPE from 25 to 33 CAGR 2.75%

Is there 3.6% CAGR unaccounted for?

Does CAPE have strong predictive power?

Sure, with two caveats.

The first is that it's pretty much useless as a market timing tool.
(The only exception is that if the CAPE indicates that the market is extremely cheap, that tends to work out pretty well pretty quickly)

The second is that you can't judge it (or any predictive model for asset prices) by the random luck of a single end date. Like today, for example.
Compare the CAPE on a starting date to, for example, the average CAGR for all holds in the range 5-10 years later. This gets rid of the luck of the end date while keeping the precision of the valuation on the start date.
The correlation is pretty good then. Dates that the CAPE figure is compelling make much better than average times to buy, and vice versa.

Personally, I also use an improvement on the E10 used in the traditional Shiller CAPE calculation.
It is intended to be a long enough period that there is at least one earnings recession in the lookback period, but occasional you will see a 10 year earnings bull market and it will give an unreasonably high estimate of the "sustainable" level of earnings.
I use four different smoothing methods then look at a simple estimate of the four estimates, so it's not overly dependent on any one critical start date...sort of the backward-looking version of the forward-looking single date problem mentioned above.
This is just a tweak, not a fundamental change to the idea.

Using my own version of CAPE for smoothign the earnings, here are the 7-year forward results for various valuation levels for purchase dates since 1995.
The 7-year figures are the average forward CAGRs for holding period lengths of 4-10 years.
The middle figure is the average return, the figures to the left and right show the range of outcomes we've seen.

                                     Lowest  Pctl 10  Average  Pctl 90  Highest
Most expensive   5%  of start dates   -4.1%    -3.8%    -3.2%    -2.4%    -2.2%
Next            10%  of start dates   -3.4%    -3.1%    -2.0%    -0.5%    -0.1%
Next            10%  of start dates   -2.2%    -1.7%     0.6%     2.5%     2.8%
Next            10%  of start dates   -0.4%     0.1%     2.2%     5.0%     5.7%
Next            10%  of start dates    1.1%     1.6%     2.9%     3.7%     9.5%
Next            10%  of start dates    1.8%     2.1%     5.4%    10.1%    10.3%
Next            10%  of start dates    2.2%     2.6%     6.5%    10.9%    11.4%
Next            10%  of start dates    3.5%     4.2%     9.2%    12.5%    12.9%
Next            10%  of start dates    5.3%     8.6%    11.9%    13.4%    14.0%
Next            10%  of start dates   10.6%    11.8%    12.7%    13.8%    14.6%
Cheapest         5%  of start dates   12.7%    13.3%    14.0%    14.5%    14.7%

Note that the BEST about-7-year forward return starting from the most expensive 5% of the time is way lower than the WORST outcome starting in the cheapest 5% of the time.
All figures adjusted for dividends and inflation, assuming the investment is the S&P 500.

Jim

Does CAPE have strong predictive power?

Sure, with two caveats.

Thanks, Jim. I knew you'd be able to explain it in a way that I could understand.

Jim, which of the CAPE valuation bands are we in today?

My estimate. There are 11 valuation bins, and the 12 breakpoints (using standard CAPE since 1995) are:

  date   CAPE   pctRank
1999.12  44.20    100%
1999.09  41.32    95%
2022.04  33.89    85%
2023.07  30.89    75%
2022.07  29.00    65%
2006.12  27.28    56%
2006.03  26.33    46%
2014.08  25.62    36%
1995.09  23.95    26%
2011.06  22.10    16%
1995.01  20.22    6%
2009.03  13.32    0%
 
2023.09  30.81    75%

We are now about at the 75% rank, close to the breakpoint between the 3rd and 4th most expensive bins (out of 11 bins total).

using data from http://www.econ.yale.edu/~shiller/data.htm

Current Shiller PE Ratio: 30.94 on Dec 5 from https://www.multpl.com/shiller-pe

"Using my own version of CAPE for smoothign the earnings, here are the 7-year forward results for various valuation levels for purchase dates since 1995."

Nice work. Thanks for sharing. What bracket are we in today?

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