What is the CAPE ratio?

The traditional price-to-earnings ratio divides a company’s stock price by its earnings per share. The CAPE ratio uses 10 years of inflation-adjusted earnings instead of just a single year for the traditional P/E ratio. This captures a company’s earnings over a full business cycle, smoothing out earnings volatility. The traditional P/E ratio can be distorted in years of unusually good or bad results.

P/E ratio = Price per share ÷ earnings per share

CAPE ratio = Price per share ÷ 10-year average inflation-adjusted earnings per share

In practice, the CAPE ratio is most often used as a barometer of overall stock market valuation. When the ratio approaches historic highs, market watchers may anticipate a market decline. A historically low CAPE ratio is considered a sign of attractive pricing, a potential buying opportunity. 

However, Shiller, a Nobel prize winner, has cautioned against making short-term investment decisions based on the CAPE ratio. He and Campbell describe the ratio as a predictor of 10-year returns. It’s a long-term metric, “not a timing mechanism.” 

Other experts have questioned whether the historic CAPE ratio average, around 17 for the S&P 500, is meaningful today, given changes in accounting rules, interest rates, demographics and other factors. 

Example: “Adwin believed Canadian stocks were less expensive on average than U.S. stocks, with the Canadian market trading at a CAPE ratio of 22, compared to 34 for the S&P 500. Although Poland looked even cheaper at 11, he felt more comfortable investing in North American markets.”

Read more on investing in stocks:

• Making sense of the markets this week
  Read about the financial headlines and get context on what they mean for Canadian investors.
• Attention, ESG investors: Canada’s biggest carbon-emitting public companies
  Are Canadian companies making progress on carbon emissions? Climate Engagement Canada’s new net-zero assessments show there’s still a long way to go.
• The best dividend stocks in Canada 2024
  Here’s our list of the top dividend stocks of the year. Use this ranking as a tool to help you identify the companies that offer the best investment potential now, based on yield, stability and value. 
• What is considered day trading in a TFSA
  The recent Ahamed v. The King decision by the Tax Court of Canada highlights risks for investors who trade frequently in their TFSAs, as well as in other investment accounts.
• Best online brokers in Canada 
  It’s the best of the best in our 2023 list of online brokers in Canada. Who takes the top spot—and which platform is best aligned with your investing goals?

About MoneySense Editors

MoneySense editors and journalists work closely with leading personal finance experts in Canada. Since 1999, our award-winning magazine has helped Canadians navigate money matters.

Linkedin Twitter Facebook Website