What is the CAPE Ratio? A Plain-English Guide
The Cyclically Adjusted Price-to-Earnings ratio, explained simply: how it works, why it smooths earnings over ten years, and what it can and cannot tell you.
The CAPE ratio — short for Cyclically Adjusted Price-to-Earnings — is one of the most widely cited measures of how expensive a stock market is. It is also called the Shiller P/E or PE10, after the economist Robert Shiller who popularised it.
The problem CAPE solves
A normal price-to-earnings (P/E) ratio divides today's price by the last year of earnings. The trouble is that earnings swing wildly with the business cycle. In a recession, earnings collapse, which makes the P/E ratio spike — making stocks look expensive exactly when they may be cheap.
CAPE fixes this by using ten years of earnings, adjusted for inflation, instead of just one. Averaging a full economic cycle gives a steadier, more comparable measure of value.
How it is calculated
CAPE = Real Price ÷ Average Real Earnings over the past 10 years
Both the price and the earnings are adjusted into today's money using a consumer price index. So a CAPE of 25 means investors are paying about 25 times a smoothed, inflation-adjusted year of earnings.
What it tells you
Historically, a high CAPE has been associated with lower long-run returns, and a low CAPE with higher returns. It is best read against a market's own history:
- Compare today's value to the long-run average and median.
- Look at the percentile rank — is today in the top 10% of all readings, or the bottom 10%?
What it does not tell you
CAPE is not a market-timing tool. Expensive markets can stay expensive — or get more expensive — for years. Accounting rules, profit margins, interest rates and the mix of industries in an index all change over decades, which can shift what counts as "normal".
Use CAPE as one input among several, not as a single verdict.