Nobel Prize winner Robert Shiller gives advice on calculating price-earning ratio
Are stocks too expensive now that the Standard & Poor’s 500 index is trading near a record high? Let’s see what the numbers of a Nobel winner have to say.
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Economist, author and Yale University professor Robert Shiller speaks at a news conference.
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Robert Shiller is one of three Americans who won the Nobel prize for economics last week. The Yale professor is known for pointing out that stock prices were rising much faster than corporate earnings in his book “Irrational Exuberance,” which came out in March 2000. The dot-com bubble popped that month.
The price-earnings ratio is one of the bedrocks of financial analysis. Investors compute it by dividing a stock’s price by the company’s earnings per share, typically over the last 12 months. A high P/E indicates a stock is more expensive than one with a lower ratio.
Shiller suggests calculating the market’s P/E using the average earnings per share over the past 10 years. This longer view smooths out temporary booms and busts, and his numbers are adjusted for inflation. Shiller calls this a cyclically adjusted price-earnings ratio, or CAPE.
According to Shiller, the S&P 500 began October with a CAPE of 24. That’s well above its historic average, yet still well below a peak of 44 in December 1999 and a peak of 33 reached before the crash of 1929.
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