When we invest in stocks, we count on the future profits and earnings of the companies we invest in. In fact, earnings are the lifeblood of corporate America.
A great way to evaluate the price of a company’s stock is to use price-to-earnings (P/E) ratios. The most commonly used measure of P/E was developed by Robert Shiller, a Yale economist and a 2013 Nobel Laureate. Wall Street typically manipulates the future predicted earnings, so instead Schiller uses a more consistent measure that looks at earnings over the past 10 years, adjusted for inflation. The result is an overall price for the stock market, and Shiller’s P/E ratio has been widely accepted as the most accurate long-term metric.
Schiller’s P/E ratio is known as the CAPE Shiller (Cyclically Adjusted Price to Earnings). The graph below shows its historical measurements.
Shiller’s P/E Ratio
The average CAPE Shiller P/E Ratio is around 17, which means that on average the stock market is priced at 17 times earnings. The further below the P/E ratio is below the average, the more the market is undervalued. If you’re a long-term investor, and if you invested when the ratio was under 10, like in 1982 when the ratio was just 6, you will have seen magnificent long-term performance over the 18-year bull run that occurred right after, ending in the all-time highs of the Shiller ratio in 2000. Investors who went in when the ratio was above 24 will have experienced poor performance, like the investors that went into the stock market after 1995 and saw their portfolio crash, with no effective gains for over 20 years.
Simply view P/E ratios as a long-term trigger to buy low and sell high—i.e., buy when the P/E ratio is low and sell when it’s high. Today, the CAPE Shiller ratio is around 30 (30.07 at the time this article was written). This signals that the market is significantly overpriced, and that future returns over many years will be very low if not zero. In other words, it’s a great time to exit the stock market and diversify your holdings.
Don’t just take our word for it. In late 2018, John Bogle, founder of The Vanguard Group, predicted that the stock market performance in the next decade will be paltry.
About Kevin Troy
Kevin has spent over 16 years in the financial industry, focused primarily on precious metals as investment assets. He has published many articles on buying and selling precious metals along with the best entry and exit strategies for various financial assets. He has helped thousands of clients protect, preserve, and safeguard their investments with precious metals and has been with Gold Alliance for more than two years as a leading Sr. Portfolio Manager, overseeing a large portion of our clients’ portfolios.