What Is the CAPE Ratio? Shiller P/E Formula and Market Insights

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The CAPE ratio (cyclically adjusted price-to-earnings ratio) divides a stock index’s current price by its average inflation-adjusted earnings over the previous 10 years. It is also called the Shiller P/E, after Yale economist Robert Shiller, who popularized it as a way to judge whether a broad stock market is expensive or cheap relative to its long-run earning power. A single year of earnings can be swollen by a boom or crushed by a recession. Averaging a decade of real earnings smooths out that business cycle.

How the CAPE ratio is calculated

CAPE ratio = Current price ÷ Average of the last 10 years of real (inflation-adjusted) earnings

Building it takes three steps:

1. Collect 10 years of earnings. For an index this means aggregate earnings per share (EPS) for the index, one figure per year.
2. Convert each year to today’s dollars. Shiller’s method uses the Consumer Price Index: real EPS = nominal EPS × (CPI today ÷ CPI in that year). If a year’s EPS was $10 when the CPI stood at 200, and the CPI is now 300, that year counts as $15 in real terms.
3. Average the 10 real figures and divide the current price by that average.

The inflation step matters because a dollar of profit earned a decade ago bought more than a dollar does now. Without it, older years would look artificially small and the ratio would be overstated.

Worked example (hypothetical)

Assume an index trades at 4,000. Its real EPS over the last 10 years, already converted to today’s dollars, was:

150, 160, 170, −20, 140, 180, 190, 200, 210, 220

The sum is 1,600, so the 10-year average is 160.

CAPE = 4,000 ÷ 160 = 25

The standard trailing P/E uses only the latest year: 4,000 ÷ 220 ≈ 18.2. Because the latest year is the strongest of the decade, the one-year P/E makes the index look cheaper than the cyclically adjusted figure does.

The example also shows how CAPE handles negative earnings. The loss year (−20) stays in the average and pulls it down, but it does not break the calculation as long as the 10-year total is positive. A one-year P/E in that loss year would be meaningless, since dividing by negative earnings gives no useful multiple.

CAPE vs. the standard P/E ratio

The P/E ratio divides price by one year of earnings, either trailing 12 months or forward estimates. CAPE differs in two ways:

• Time window: CAPE uses a decade of earnings, a standard P/E uses one year or less.
• Inflation: CAPE restates every year in current dollars. A standard P/E uses nominal figures.

The standard P/E describes price relative to recent profits. CAPE describes price relative to average profits across a full cycle. Near a profit peak, CAPE tends to read higher than the trailing P/E, as in the example. After a profit collapse, the trailing P/E can spike or become undefined while CAPE moves far less.

Why use 10 years of earnings?

Corporate profits climb in expansions and shrink or turn into losses in recessions. The swings are larger in cyclical industries such as commodities and financials than in steadier ones like utilities, and deep recessions hit earnings across most of the market. Those swings make one-year P/E ratios jump around. In their 1934 book Security Analysis, Benjamin Graham and David Dodd recommended averaging earnings over several years, preferably seven to 10, when judging valuation. CAPE applies that idea to an entire market, using 10 years as the window.

How investors use the CAPE ratio

CAPE is usually calculated for broad indexes such as the S&P 500. The most common uses are:

• Comparing a market with its own history. A reading well above the index’s long-run average suggests prices are high relative to past earning power. A reading well below suggests the opposite.
• Setting long-horizon return expectations. Shiller and Campbell’s research linked high starting valuations to weaker real returns over the following decade. That makes CAPE more relevant to a 10-year outlook than to next month’s move.
• Comparing markets. Investors sometimes compare CAPE readings across countries. Differences in sector mix, accounting and growth rates mean those comparisons need care.

Where the CAPE ratio came from

The measure gained wide attention in December 1996, when Robert Shiller and John Campbell presented research to the Federal Reserve arguing that stock prices were rising faster than earnings. In 1998 they published “Valuation Ratios and the Long-Run Stock Market Outlook,” which averaged the S&P 500’s real earnings over 10 years using data reaching back to 1872.

The ratio hit a then-record of about 28 in January 1997. The only comparably high reading in their data was in 1929. Based on that level, they projected that the market’s real value would be roughly 40% lower a decade later. The S&P 500 then lost more than half its value between October 2007 and March 2009. Shiller later shared the 2013 Nobel Memorial Prize in Economic Sciences, partly for work on asset prices.

During the 2010s, the S&P 500’s CAPE climbed above 30, a level previously reached only around 1929 and 2000, setting off a long debate over whether the high level pointed to a major correction.

Limitations of the CAPE ratio

• It looks backward. Ten years of past earnings may poorly represent future profits, especially if the economy’s structure or the index’s makeup has changed.
• Accounting changes distort the history. CAPE is typically built on GAAP earnings, and GAAP rules have changed over time. In a 2016 paper, Wharton’s Jeremy Siegel argued that these changes depress reported earnings in recent periods, which makes CAPE-based return forecasts too pessimistic. He found that using more consistent earnings series, such as operating earnings or national income (NIPA) profits, improved the model’s forecasts.
• Long stretches above average. A market can stay at a high CAPE for years, and a high reading has at times been followed by further gains. The ratio says nothing about the timing of a decline, so using it to time exits can mean missing long periods of gains.
• Other influences go unmeasured. Interest rates, payout policy and sector weights all affect what valuation is reasonable, and CAPE does not adjust for any of them.

FAQs

The Bottom Line

The CAPE ratio matters most to long-horizon investors judging whether a broad index such as the S&P 500 is expensive relative to its own history. Research by Shiller and Campbell linked high starting valuations to weaker real returns over the following decade, so the ratio fits a 10-year outlook better than short-term timing. Its backward view, shifting accounting rules and blindness to interest rates and sector weights mean any reading deserves caution.