Shiller P/E Valuation
The Shiller P/E (CAPE) Ratio is a powerful market valuation indicator developed by Nobel laureate Robert Shiller. This metric compares current stock prices with inflation-adjusted 10-year average earnings, providing investors with a reliable tool to assess market valuations and identify potential investment opportunities.
Calculation Parameters
Note: Please enter the P/E ratio range.
Net Profit Trend
Let's break down the Shiller P/E valuation method into several key steps:
1. Calculate Cyclically Adjusted Earnings
While traditional P/E ratios use the most recent year's earnings, the Shiller P/E uses a 10-year inflation-adjusted average earnings per share (EPS). This approach helps smooth out economic cycles and short-term fluctuations, resulting in a more stable valuation metric.
This step involves:
- Collecting EPS data for the past 10 years
- Adjusting these earnings for inflation using CPI
- Calculating the average of the inflation-adjusted EPS
2. Calculate Shiller P/E Ratio
The Shiller P/E ratio is calculated by dividing the current stock price by the average earnings per share from the past 10 years. This ratio tends to be more stable than traditional P/E ratios because it uses a longer period of earnings.
3. Evaluate Valuation Levels
Comparing the calculated Shiller P/E ratio to historical averages or industry benchmarks can provide a general idea of whether a company's stock is overvalued, undervalued, or fairly valued. Generally:
Overvalued
When the Shiller P/E is above historical averages, it suggests high market expectations and potential bubble risks.
Undervalued
When the Shiller P/E is below historical averages, it may indicate undervaluation and potentially attractive investment opportunities.
4. How to Use Shiller P/E for Valuation
Calculate the average net profit of a company over the past 10 years, considering the Shiller P/E ratio, industry P/E ratios, and risk-free rate of return. This helps estimate a reasonable range of P/E ratios, which can then be used to determine the company's fair value.
Calculation Example:
Assume a company's annual net profits (in B) over the past 10 years:
2.410, 3.390, 4.450, 6.010, 5.820, 1.880, 4.000, 6.060, 2.790, 4.800
Step 1: Calculate 10-year average profit
Average Net Profit = (2.410 + 3.390 + ... + 4.800) ÷ 10 = 4.161
Step 2: Determine a reasonable P/E ratio range
Assuming a comprehensive analysis of historical Shiller P/E ratios, industry trends, and current market conditions, it's estimated that a reasonable P/E ratio range is 10-15.
Step 3: Calculate the fair value range
Lower Bound = 4.161 × 10 = 41.610
Upper Bound = 4.161 × 15 = 62.415
Therefore, the fair value range for this company is: 41.610 ~ 62.415
5. Supplemental Financial and Industry Analysis
The Shiller P/E is an important tool in valuation, but it should not be used as the sole basis for investment decisions. For individual companies, additional analysis of financial health, profitability, and market competitiveness is required.Additionally, the Shiller P/E is more applicable to companies with a clear economic cycle.
Historical Data Explanation
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Figure: 1860-2040 Shiller P/E (CAPE) vs Long-term Interest Rates
This chart shows two main economic indicators over the period from 1860 to 2040: Shiller P/E (CAPE) and long-term interest rates. Here's a detailed explanation of the chart:
1. Shiller P/E (CAPE)
CAPE (Cyclically Adjusted Price-to-Earnings Ratio) is a method proposed by economist Robert Shiller. It considers the average earnings over the past 10 years to smooth out economic fluctuations. The blue line in the chart represents the changes in CAPE, which is commonly used to assess the level of stock market valuation. Higher CAPE values may indicate overvaluation, while lower values may indicate undervaluation.
2. Long-term Interest Rates
The red line in the chart represents the changes in long-term interest rates, which are typically the yields of long-term government bonds. Interest rate changes can significantly impact investor decisions, as higher rates may reduce the attractiveness of stocks relative to bonds.
3. Chart Trends
The chart shows that CAPE has experienced significant fluctuations over the years, particularly during the following key historical periods:
- 1929 Wall Street Crash:Led to the Great Depression lasting nearly a decade.
- 1981 Stagflation:U.S. economy experienced stagflation (stagnation + inflation).
- 2000 Dot-com Bubble:Tech stock bubble burst leading to significant market correction.
Long-term interest rates rose in the mid-20th century before falling in the early 21st century, and have recently started to rise again.
4. Relationship Between CAPE and Interest Rates
Typically, CAPE and long-term interest rates have an inverse relationship: when interest rates rise, CAPE tends to fall, and vice versa. This is because higher interest rates increase the cost of capital, making stocks less attractive.