Thomas M. Arnold

A Cautionary Note about Robert Shiller’s CAPE

AAII Journal suggests that stocks are certainly not overvalued to the degree predicted by the CAPE analysis and may actually be undervalued. Thus, investors are left in a quandary as to which measure of valuation is most appropriate. This article makes the case that the comparison of the July 2011 CAPE to its long-term average provides an overly bearish view of the stock market and that the traditional price-earnings ratio based on either reported earnings or operating earnings is a better measure of the worth of U.S. equities in July 2011. As fi rst used by Shiller in his book, the CAPE was undoubtedly a very useful tool for identifying overvaluation at the height of the late-1990s stock market “bubble.” However, like all other valuation metrics, the CAPE has its limitations, and these limitations derive from how it is computed.