The CAPE ratio compares an equity index level with ten-year average inflation-adjusted earnings.
The cyclically adjusted price-to-earnings ratio, commonly called the CAPE ratio or Shiller P/E, compares a broad equity-market price index with the average of ten years of inflation-adjusted earnings. The long earnings window is intended to reduce the effect of one recession, profit boom, or short-term earnings shock.
CAPE describes historical valuation under a specified data method. It does not identify the exact timing of a market turning point, guarantee future returns, or establish that a market is objectively overvalued or undervalued.
For current index level (P_t), historical earnings (E_{t-i}), and a price index such as CPI, first restate each earnings observation in current-price terms:
Then average the real earnings over ten years:
The simplified annual CAPE formula is:
Actual published series may use monthly observations, interpolated earnings, specific index histories, and a defined inflation series. A reproduced value should follow the source methodology rather than combining figures from unrelated providers.
Assume a broad equity index is at 4,800. After converting each of the previous ten years of index earnings into current-price terms, the average real earnings are 200 index points.
The corresponding cyclically adjusted earnings yield is:
Suppose the latest 12-month earnings are 240. The conventional trailing P/E would be:
The trailing P/E is lower because current earnings exceed the ten-year real average. That may reflect stronger current profitability, a recovery from weak years, structural change, or a cyclical peak. CAPE does not determine which explanation is correct.
Corporate profits fluctuate with recessions, commodity prices, credit losses, margins, taxes, and one-time events. Dividing current price by only one weak earnings year can produce an unusually high P/E, while using peak earnings can make valuation look unusually low.
The ten-year real average attempts to place current price against an earnings base spanning more of a business cycle. Inflation adjustment makes earnings from different years more comparable in purchasing-power terms.
The smoothing creates trade-offs. Older earnings may describe companies, sectors, accounting rules, margins, and payout policies that differ from the current index. A fixed ten-year window can also respond slowly to durable structural change.
| Measure | Earnings denominator | Main use | Main limitation |
|---|---|---|---|
| CAPE | Ten-year average inflation-adjusted earnings | Long-horizon broad-market valuation context | Slow-moving and method-sensitive |
| Trailing P/E | Latest year or four quarters of earnings | Current price relative to recent reported earnings | Sensitive to current-cycle peaks, troughs, and unusual items |
| Forward P/E | Forecast earnings for a future period | Price relative to expected near-term earnings | Depends on estimates that may be revised or wrong |
| Earnings Yield | Current, forecast, or normalized earnings divided by price | Percentage presentation of a stated P/E basis | Not a distribution or promised return |
These measures can disagree without any calculation being wrong. They use different earnings windows and answer different questions.
CAPE is most commonly applied to diversified equity indexes. Applying it to one company is more difficult because an individual firm may:
A diversified index also changes composition, but one company’s ten-year history is usually more exposed to firm-specific discontinuities. For individual-stock valuation, normalized earnings and multi-stage cash-flow analysis may be more direct.
Analysts may use CAPE to:
The ratio should not be converted into a precise market forecast. Historical relationships are sample-dependent, and an elevated ratio can remain elevated or rise further for an extended period.
Reported versus operating earnings, treatment of losses, share-count methods, and restatements can change the denominator. Confirm that price and earnings belong to the same index series.
The selected consumer-price index, observation dates, revisions, and treatment of monthly versus annual data affect real earnings.
Sector weights, constituent changes, float adjustment, market-cap weighting, and geographic scope make CAPE levels across indexes difficult to compare.
Share repurchases can change earnings per share and index valuation differently from cash dividends. Robert Shiller’s public data page includes a total-return CAPE variant intended to address changes in payout policy. It is a separate methodology, not a drop-in replacement for the conventional series.
Required returns, inflation uncertainty, profitability, growth expectations, and bond yields can affect the valuation investors accept. CAPE alone does not model these variables or specify a justified ratio.
Before relying on a CAPE value, document:
Shiller’s Yale page documents the long-run U.S. data and alternative total-return CAPE series. Campbell and Shiller examine valuation ratios as long-horizon forecasting variables. Those historical relationships do not make CAPE a deterministic market-timing rule.
This article provides general financial education. It does not provide personalized investment, market-timing, valuation, tax, accounting, or legal advice and does not forecast market returns.