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New Page Added – Shiller P/E Market Valuation

November 03, 2011 | About:

GuruFocus is very pleased to announce the addition of new Shiller P/E page. The new Shiller P/E is a complement to our page of market valuation based on total market cap over GDP. This is the link to the new Shiller P/E page.

Prof. Robert Shiller of Yale University invented the Schiller P/E to measure the market’s valuation. The Schiller P/E is a more reasonable market valuation indicator than the P/E ratio because it eliminates fluctuation of the ratio caused by the variation of profit margins during business cycles. This is similar to market valuation based on the ratio of total market cap over GDP, where the variation of profit margins does not play a role either.

This is the Shiller P/E chart:


As of today, Shiller P/E sits at 21.1, 28.7% higher than the historical mean of 16.4. This implies an annual stock market return of 3.3% in future years. As a comparison, regular P/E of S&P 500 is 15, which is below the historical mean of 15.8.

The implied 3.3% is lower than what we predict in the page of to market valuation based on the ratio of total market cap over GDP, which sits at 5.2%. They are within less than 2% a year for future returns. It is hard to say which one is more accurate. Currently they both indicate low future returns.

How Is the Shiller P/E Calculated?

  1. Use the annual earnings of the S&P 500 companies over the past 10 years.
  2. Adjust the past earnings for inflation using CPI; past earnings are adjusted to today’s dollars.
  3. Average the adjusted values for E10.
  4. The Shiller P/E equals the ratio of the price of the S&P 500 index over E10.
When Is the Regular P/E Ratio Deceiving?

The regular P/E uses the ratio of the S&P 500 index over the trailing-12-month earnings of S&P 500 companies During economic expansions, companies have high profit margins and earnings. The P/E ratio then becomes artificially low due to higher earnings. During recessions, profit margins are low and earnings are low. Then the regular P/E ratio becomes higher. It is most obvious in the chart below:


The highest peak for the regular P/E was 123 in the first quarter of 2009. By then the S&P 500 had crashed more than 50% from its peak in 2007. The P/E was high because earnings were depressed. With the P/E at 123 in the first quarter of 2009, much higher than the historical mean of 15, it was the best time in recent history to buy stocks. On the other hand, the Shiller P/E was at 13.3, its lowest level in decades, correctly indicating a better time to buy stocks.

Shiller P/E Implied Market Return

If we assume that over the long term, the Shiller P/E of the market will reverse to its historical mean of $mean, the future market return will come from three parts:

  1. Contraction or expansion of the Schiller P/E to the historical mean
  2. Dividends
  3. Business growth
The investment return is thus equal to:

Investment Return (%) = Dividend Yield (%) + Business Growth(%) + (Mean_Shiller_PE/Current_Shiller_PE)(1/T)-1

From this we will estimate that at the Shiller P/E’s current level, the future market return will be around 3.3% a year.

Investment Strategies at Different Market Levels

The Shiller P/E and the ratio of total market cap over GDP can serve as good guidance for investors in deciding their investment strategies at different market valuations. Historical market returns prove that when the market is fair or overvalued, it pays to be defensive. Companies with high quality business and strong balance sheet will provide better returns in this environment. When the market is cheap, beaten down companies with strong balance sheets can provide outsized returns.

To summarize:

  1. When the market is fair valued or overvalued, buy high-quality companies such as those in the Buffett-Munger Screener.
  2. When the market is undervalued, buy low-risk beaten-down companies like those in the Ben Graham Net-Net Screener. Buy a basket of them and be diversified.

About the author:

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

Rating: 2.9/5 (71 votes)


Tkervin - 5 years ago    Report SPAM
Very helpful. Thank you.
Bill.Smith - 5 years ago    Report SPAM
Thanks for adding this, GF.
Halle - 5 years ago    Report SPAM
Thank yoou for adding this. Very useful
SpatialK - 5 years ago    Report SPAM
So,..only fifteen or twenty years to wait for those 10% + returns to be available once more!!!

Where be the "cheap assets"?

Or is it back to "trading" ( or poker?)
Earlberger - 5 years ago    Report SPAM
The Schiller index definitely does not 'compliment' existing indices; I think you mean that it 'complements'.

It may seem picky but if you want us to trust your analyses, it helps to get the English right.
Gurufocus premium member - 5 years ago
It has been corrected. Thank you for pointing it out, Earlberger!

Bdarbyson - 5 years ago    Report SPAM

Enlightening....thank-you GF.
Rlawson36 premium member - 5 years ago

It would be helpful to have a copy editor take a look at some of these. For example, I'm not sure exactly what this means:

  1. Average the adjusted values for E10.
  2. The Shiller P/E equals the ratio of the price of the S&P 500 index over E10.

Does 1 mean, "average the last 10 years of earnings?" I would guess that, but it's really hard to know exactly what "average the adjusted values for E10. What are "adjusted values?" What is "E10?"

Under 2, is the "price of the S&P 500" referring to the PE ratio of the S&P 500? Earnings?

I hate to say it, and I don't mean to be a pain, but I just don't get what you mean.

Stillsolvent - 5 years ago    Report SPAM

Imputed 3.3% real or nominal returns?

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