Shiller P/E Ratio: How To Value The Stock Market (2024)

The Shiller P/E ratio helps investors understand whether the stock market as a whole is overvalued or undervalued. This handy analytical tool helps gives you a longer-term view that corrects for short-term volatility, and it can also be used to value individual stocks. It’s also known as the cyclically adjusted price-to-earnings ratio (CAPE) or the Shiller P/E 10.

Understanding the Shiller P/E Ratio

To understand the Shiller P/E ratio you first have to understand the price-to-earnings ratio. The P/E ratio tells you whether a single company is undervalued or overvalued by comparing its stock price to its earnings per share (EPS). High P/E ratios generally signify a company is overvalued whereas low ones indicate it may be a good value buy with the potential for high future returns.

The problem is that standard P/E ratios depend on short-term changes in a company’s earnings performance that have little to do with its fundamentals and lots to do with big market-moving economic events. These can include things like a market correction, a recession or big changes in a company’s industry.

That’s why Yale University Professor Robert Shiller proposed looking at inflation-adjusted 10-year earnings data to minimize the impact of short-term impacts. This way investors could better determine whether an index was truly over or undervalued.

While it can be used to analyze individual stocks, the Shiller P/E ratio is generally applied to an entire stock market index, most often the . When used in this fashion, the Shiller P/E ratio provides an accurate measure of the value of an entire stock index that smooths out the short-term earnings volatility experienced by its constituent companies.

How to Calculate the Shiller P/E

The formula for the Shiller P/E ratio is simple: current price divided by average inflation-adjusted 10-year EPS.

To do that, you’ll need to find an index’s EPS for each of 10 years, adjust each for inflation to bring it into current dollars and find their average. You’ll then divide the index’s current price by this average.

You can, of course, assemble all of these data points for an entire index by using corporate earnings reports and inflation calculators all by yourself. Or you can use resources like Shiller’s Yale website, which already has done most of the heavy lifting for you.

Let’s use data from his site to calculate the Shiller P/E ratio for the S&P 500 as of June 2021:

• S&P 500 Price: $4,258.88
• S&P 500 10-year average EPS: $103.65
• Inflation-adjusted EPS: $116.06

Divide the S&P 500 price, $4,258.88, by the inflation-adjusted average earnings from the prior 10 years, $116.06, to get a Shiller P/E of 36.70 for June 2021.

You can view the CAPE throughout history directly on Shiller’s website going back to 1871.

What Does the Shiller PE Tell You?

The Shiller P/E gives investors a read on whether the stock market—as represented by the S&P 500—is overvalued or undervalued. The higher the Shiller P/E ratio, the more overvalued a market.

For context, over more than 100 years, the average and median Shiller P/E ratio has been around 15 or 16, spiking up significantly higher often before market crashes.

But the all-time high in the Shiller P/E ratio was December 1999, when the figure reached 44.19. This high coincided with the dot-com driven rally in tech stocks of the late 1990s. Based in part on that record high ratio, Shiller correctly predicted that the dot-com frenzy would turn out to be a bubble.

Shiller’s research bears out what we know intuitively: Lower valuations suggest the potential for higher returns from equities over the long run. An elevated Shiller P/E could suggest that a market correction might be on the horizon.

Limitations of the Shiller P/E

Like many other metrics, the Shiller P/E ratio is backward-looking, based on historical performance figures, leading some critics to question its utility as the economy and countries’ economic policies evolve.

Shiller himself has proposed an alternative calculation based on recent changes in corporate payout practices. For example, many companies have moved toward share repurchases rather than dividends as a way to distribute cash to shareholders. Widespread use of this payout mechanism can impact the average EPS figures used to calculate the Shiller PE. To account for this, Shiller now proposes a total return CAPE that reinvests dividends into the price index.

Other research has suggested that using the Shiller P/E to forecast equity returns could yield overly pessimistic results based on changes in GAAP (generally accepted accounting principles) methods for calculating earnings. Professor Jeremy Siegel from the Wharton School of Business suggests that using operating earnings instead of GAAP earnings may enhance the predictive power of the Shiller P/E.

How Can You Use the Shiller P/E Ratio

Individual investors can use the Shiller P/E as one tool in evaluating potential equity market performance. You won’t need to calculate a Shiller P/E for the market yourself. Multiple online sources publish the current Shiller P/E as well as historical averages.

While a high Shiller PE may offer insights into the market’s (or an individual stock’s) valuation and what could portend for it, investors should always rely on multiple inputs when making investment decisions.