“Stocks are cheap!” “Stocks are expensive!” It’s one of the oldest debates on Wall Street—and an especially good way to divide investors into competing camps as the U.S. bull market soldiers on in its seventh year.
Each side needs evidence for its arguments, of course, which leads us to competing versions of the price-earnings ratio. The more mainstream metric simply divides the level of an index by the past year’s earnings per share for member companies. A more complex measure of how rich stocks are getting divides the index level by average earnings over 10 years. Yale University economics professor Robert Shiller calls this the CAPE ratio, which stands for cyclically adjusted price-earnings. Others simply call this 10-year version the Shiller P/E for the man who made it famous—the author of the book Irrational Exuberance, which came out in 2000 after an exuberant period that pushed the CAPE ratio to an all-time high.