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How to Apply the Shiller P/E to Individual Stocks

June 27, 2012 | About:
Shiller P/E, invented by Yale professor Robert Shiller, has been very successful in evaluating current market valuation and predicting future market returns. It is a great complement of the market valuation based on the ratio of total market cap over GDP. In this article we would like to discuss the interesting aspects of how to apply the Shiller P/E to individual companies. In the new improved 10-year financial page on GuruFocus, the stock’s historical Shiller P/E ratio was added. A daily chart will be displayed if you click on the row of data.

The Shiller P/E is calculated by dividing the daily stock price by the multi-year inflation adjusted earnings, E10. Here we use a similar calculation for individual companies. When we calculate today’s Shiller P/E ratio of a stock, we use today’s price divided by E10.

How do we calculate E10? E10 is the average of the inflation adjusted earnings of a company over the past 10 years. Let’s use an example to explain.

If we want to calculate the E10 of Walmart (NYSE:WMT) for Dec. 31, 2010, we need to have the inflation data and the earnings from 2001 through 2010.

We adjusted the earnings of 2001 earnings data with the total inflation from 2001 through 2010 to the equivalent earnings in 2010. If the total inflation from 2001 to 2010 is 40%, and Walmart earned $1 a share in 2001, then 2001’s equivalent earnings in 2010 are $1.4 a share. If Walmart earns $1 again in 2002, and the total inflation from 2002 through 2010 is 35%, then the equivalent 2002 earnings in 2010 are $1.35, and so on and so forth until you get the equivalent earnings of the past 10 years. Then you add them together and divide the sum by 10 to get E10.

In our calculation of daily Shiller P/E, we used six years of average earnings instead of ten years.

What does the Shiller P/E tell us for individual companies? Let’s use a few examples to explain.

Consider a company that is consistently growing at a reasonable pace, WalMart. The Shiller P/E and regular P/E give similar pictures.



But for a fast grower like Apple (NASDAQ:AAPL), the Shiller P/E and regular P/E give a totally different picture. Below are the regular P/E and Shiller P/E charts for Apple.



We can see that the regular P/E (ttm) tells us Apple is valued at about 14 times earnings. But Shiller P/E is suggesting that it is traded at about 30 times inflation adjusted earnings. A Shiller P/E of 30 for Apple comes from its tremendous growth.

The Shiller P/E works best for companies with cyclical profit margins, just as it was designed for the S&P 500. Take a look at the regular P/E and Shiller P/E of Deere (NYSE:DE).



If we take a look at the regular P/E ratio of Deer at 2009, it is a reasonable number of 8. But it jumped to 24 suddenly in 2009. The reason is not because Deere's stock price jumped, but because Deere’s earnings declined dramatically in 2009. The Shiller P/E of Deere gives you a real picture of the valuation for cyclical companies like Deere or Progressive Insurance (NYSE:PGR). In this sense, the Shiller P/E works like P/S; it just gives you a more direct idea of valuation. Because of this, the Shiller P/E of companies in different industries can be compared. Comparing the P/S ratios of companies in different industries does not make much sense.

In conclusion, just as it was designed, the Shiller P/E works well for companies with more cyclical business in the valuation of individual companies.

The Shiller P/E is a new item added to the improved 10-Year Financial Page. It is for Premium Members only. If you are not a Premium Member, we invite you to take a 7-day Free Trial.

Rating: 2.4/5 (21 votes)


Saurabhlal193 - 4 years ago    Report SPAM
How did you calculate the total inflation from 2001 to 2010?
Gurufocus premium member - 4 years ago
You compound the annual inflation over time.

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