A cyclically adjusted price/earnings ratio, otherwise known as the CAPE, or Shiller PE after Robert Shiller, who popularised it, measures the price of a company's stock relative to average earnings over the past 10 years. Its raw form – originally used for individual stocks by Benjamin Graham and David Dodd – was modified by Prof Shiller to adjust for inflation.
The Shiller PE aims to smooth out the economic and profit cycles to give a more informed view of a company's price than the traditional price earnings ratio, which uses only one year of profits. The traditional P/E ratio compares the share price to either the past year's earnings or forecast earnings, typically for the next 12 months.
The smoothing achieved by looking at earnings over a 10-year period avoids concluding a market is cheap or expensive based on unsustainable one-year swings in profits, either up or down. But critics point out the choice of a 10-year period is arbitrary, and neither the economic nor profit cycles follow neat 10-year patterns. Many also question the use of data provided by Prof Shiller for profits back to the late 19th century, arguing that changes to accounting standards - as well as varying enforcement of the rules - makes them hard to compare.
In May 2013 it was reported that stock markets in southern Europe were beginning to attract the attention of hedge funds due to their low cyclically adjusted PE ratios. The US market looks either at, or over, long term valuations, depending where you take your starting point. Spain's stock market was on a Shiller earnings multiple of 8.9 – less than half its long-run valuation of 20.8.
In September 2013 an FT analysis looked at the clash of opinions between Robert Shiller and another renowed economist, Jeremy Siegel. According to Prof Shiller US equities were very overvalued whereas Prof Siegel argued the data on which CAPE relies were unreliable. His own model showed US stocks to be undervalued.