Cyclically Adjusted Price to Earnings ratio
(CAPE).
The CAPE ratio compares the equity value of a company with its averaged adjusted accounting earnings (profit after tax).
It is a variant on the Price earnings ratio (PE ratio).
While the PE ratio is calculated as:
PE ratio = Current equity value ÷ Earnings
the CAPE adjusts the Earnings figure with the aim of providing a broader and longer term view of profitability.
The earnings figure for the CAPE ratio is the average of the inflation-adjusted earnings for the previous 10 years:
CAPE ratio = Current equity value ÷ Average inflation-adjusted earnings for previous 10 years
- Example
- Company A's total equity value is $600m and its relevant average inflation adjusted earnings are $50m,
- The CAPE ratio = $600m / $50m
- = 12
The Price to earnings ratio reflects the market's perception of the risk and the future growth prospects of the company.
A higher CAPE ratio generally indicates that the market perceives:
- better growth
- lower risk
- or both
Lower CAPE ratios suggest lower growth (or indeed decline), higher risk, or both.
CAPE ratios can also be used as a very simple estimation or comparison model, for corporate valuation.
Simplistically, shares trading on low CAPE ratios might be perceived as relatively cheap. Similarly, shares trading on higher PE ratios might be seen as relatively expensive.
A better use of CAPE ratios is as a sense-check of the results and insights from other valuation methods.
Also known as the Shiller PE ratio, after its originator Robert Shiller.
