P/E 10 Ratio

What is the 'P/E 10 Ratio'

The P/E 10 ratio is a valuation measure, generally applied to broad equity indices, that uses real per-share earnings over a 10-year period. The P/E 10 ratio uses smoothed real earnings to eliminate the fluctuations in net income caused by variations in profit margins over a typical business cycle. The ratio was popularized by Yale University professor Robert Shiller, who won the Nobel Prize in Economic Sciences in 2013. It attracted a great deal of attention after Shiller warned that the frenetic U.S. stock market rally of the late-1990s would turn out to be a bubble. The P/E 10 ratio is also known as the "cyclically adjusted PE (CAPE) ratio" or "Shiller PE ratio."

BREAKING DOWN 'P/E 10 Ratio'

The P/E 10 ratio is based on the work of renowned investors Benjamin Graham and David Dodd in their legendary 1934 investment tome “Security Analysis.” Graham and Dodd recommended using a multi-year average of earnings per share (EPS) – such as 5, 7 or 10 years – when computing P/E ratios to control for cyclical effects.

The P/E 10 ratio is calculated as follows – take the annual EPS of an equity index such as the S&P 500 for the past 10 years. Adjust these earnings for inflation using the CPI. Take the average of these real EPS figures over the 10-year period. Divide the current level of the S&P 500 by the 10-year average EPS number to get the P/E 10 ratio or CAPE ratio.

The P/E 10 ratio varies a great deal over time. According to data first presented in Shiller’s bestseller “Irrational Exuberance” (which was released in March 2000, coinciding with the top of the dot-com boom), updated to cover the period 1881 to November 2013, the ratio has varied from a low of 4.78 in December 1920 to a peak of 44.20 in December 1999.

A criticism of the P/E 10 ratio is that it is not always accurate in signaling market tops or bottoms. For example, an article in the September 2011 issue of the "American Association of Individual Investors’ Journal" noted that the CAPE ratio for the S&P 500 was 23.35 in July 2011. Comparing this ratio to the long-term CAPE average of 16.41 would suggest that the index was more than 40% overvalued at that point. The article suggested that the CAPE ratio provided an overly bearish view of the market, since conventional valuation measures like the P/E showed the S&P 500 trading at a multiple of 16.17 (based on reported earnings) or 14.84 (based on operating earnings). Although the S&P 500 did plunge 16% during a one-month span from mid-July to mid-August 2011, the index subsequently rose more than 35% from July 2011 to new highs by November 2013.

RELATED TERMS
  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  2. P/E 30 Ratio

    The price-to-earnings (P/E) ratio is the valuation ratio of a ...
  3. Forward Price To Earnings - Forward ...

    A measure of the price-to-earnings ratio (P/E) using forecasted ...
  4. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained ...
  5. Trailing Price-To-Earnings - Trailing ...

    The sum of a company's price-to-earnings, calculated by taking ...
  6. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
Related Articles
  1. Investing

    Can Investors Trust The P/E Ratio?

    The P/E ratio is one of the most popular stock market ratios, but it has some serious flaws that investors should know about.
  2. Markets

    Getting On The Right Side Of The P/E Ratio Trend

    Buying at the right time is crucial, but how do we know when that is?
  3. Investing

    Beware False Signals From The P/E Ratio

    The P/E ratio is a simple tool for evaluating a company, but no one ratio can tell the whole story.
  4. Investing

    Is Stock With a Lower P/E Always A Better Choice?

    Is a stock with a lower P/E always a better investment than a stock with a higher one? The short answer is no, but it depends on a few things.
  5. Investing

    Comparing the P/E, EPS And Earnings Yield

    Here are three ratios that help investors value stock returns.
  6. Investing

    Explaining Forward Price-to-Earnings Ratio

    The estimated P/E of a company is often used to compare current earnings to estimated future earnings.
  7. Markets

    How Do I Calculate the Price-Earnings Ratio?

    If Apple is trading at $108.73 per share, and its trailing twelve months' EPS is $6.45, calculate the P/E ratio as...
  8. Markets

    Why Earnings Results Have Not Mattered to the U.S. Equity Markets

    Discover why the U.S. stock market is probably in an asset bubble, how stock prices became detached from the fundamentals and why the Fed is the main culprit.
  9. Trading

    How To Use The P/E Ratio And PEG To Tell A Stock's Future

    While the price-to-earnings ratio is commonly used for assessing stock prices, the price/earnings-to-growth ratio offers forecasting advantages that investors need to know.
  10. Investing

    Differences Between Forward P/E And Trailing P/E

    The most common types of price to earnings ratios are forward P/E and trailing P/E. Find out how they differ and the advantages and drawbacks of each.
RELATED FAQS
  1. What is the average price-to-earnings ratio in the banking sector?

    Explore the price/earnings ratio in regard to the banking industry and learn what the average P/E ratio is for most banking ... Read Answer >>
  2. How do I calculate the P/E ratio of a company?

    Find out how to calculate this common valuation ratio and what the results can tell you about a company's performance. Read Answer >>
  3. How can the price-to-earnings (P/E) ratio mislead investors?

    A low P/E ratio doesn't automatically mean a stock is undervalued, just like a high P/E ratio doesn't necessarily mean it ... Read Answer >>
  4. What does the forward p/e indicate about a company?

    Explore the forward price to earnings ratio and learn its significance and how it compares to the traditional price to earnings ... Read Answer >>
  5. How can I find the P/E ratio on an ETF's underlying index?

    Learn how analysts and investors can determine the price-to-earnings ratio for the underlying index of an exchange-traded ... Read Answer >>
  6. What's the difference between absolute P/E ratio and relative P/E ratio?

    The simple answer to this question is that absolute P/E, which is the most quoted of the two ratios, is the price of a stock ... Read Answer >>
Hot Definitions
  1. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  2. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  3. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  4. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
  5. Weighted Average Life - WAL

    The average number of years for which each dollar of unpaid principal on a loan or mortgage remains outstanding. Once calculated, ...
  6. Real Rate Of Return

    The annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other ...
Trading Center