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Video- Shiller P/E: How to Know If the Current Market Is Expensive

Charlie Tian introduces Shiller P/E market evaluation

March 26, 2020

Hi fellow investors,

This is Charlie Tian with GuruFocus again. Today I want to introduce the Shiller P/E. Shiller P/E is considered a better measure of overall market valuation than the regular price-earnings ratio. It was created by Professor Robert Shiller of Yale University. So how does it work?

You can find the Shiller P/E on GuruFocus.com under the "Market" tab. The page is updated once every 10 minutes during market hours. It stays as close to real-time data as possible, which is important with the market in its current state.

The data is from 1880 until present, so it represents over 140 years of data. As of today, the Shiller P/E is sitting at 23.5, which is still 37.9% higher than the historical mean of 17. It is calculated by using the annual earnings of S&P 500 companies over the past 10 years.

Past earnings are adjusted for inflation using CPI to make them equivalent to today’s dollars. The two values are then averaged together to get normalized earnings for the last 10 years. The Shiller P/E is then calculated by dividing the S&P 500 index price by the normalized earnings.

Using this calculation, you are able to smooth out recession periods that would otherwise indicate low earnings and profit margins. This gives you a much better indication of current market valuation. It will also show you historical peaks, two being located in 1929 just before the Great Depression and in 1999 during the tech bubble.

If you compare the Shiller P/E with the regular P/E, you will see a peak 10 years later in 2009 during the recession. At this time, the economy declined quickly, showing the high ratio numbers. In this case, the regular P/E does not give you the full picture of market valuation as the market was down almost 60% during that peak.

Looking at the current regular P/E, it shows the market at about 17.5 and shows that the market is probably fairly valued. In comparison, the Shiller P/E is sitting at 23.5 and gives a more accurate representation of current market value. It can also be used to predict future market returns.

If we assume over the next few years that the Shiller P/E will revert to the mean, we can estimate how much return we will get. At the mean number, the average gain would sit around 1.7% moving forward. This is a similar number to what we have previously seen when using the Buffett Indicator. If we are lucky in the future, the market will be sitting very high and the Shiller P/E shows that we could get upwards of 6.7% in returns.

Shiller P/E can also be used within a particular sector or for looking at specific stocks. It is especially useful when looking at stocks that are more cyclical in nature.

Thank you for listening and watching. If you have any comments or questions, please leave them in the comment area below and I will answer them as soon as possible.

See you next time,

Charlie Tian

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About the author:

Charlie Tian, Ph.D., is the founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

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