In order to avoid seasonal changes and various point distortions in companies’ profits, Shiller developed the CAPE index for cyclically and inflation-adjusted profit multiples. The index is designed to provide a more stable and reliable picture of the companies’ profits over time. Using the indicator, we can compare to the average earnings in the last decade, and thus identify overpricing or underpricing in the stock market in the long term. The figure is very common for use among investors for the purposes of a comprehensive analysis of the company and the index in general.
Shiller is known for two accurate predictions he gave in the past. In one of them he described in detail the development of the dot.com bubble back in the late nineties of the last century, before it exploded and shook the world economy. He was also the one who warned about the housing bubble in the US as early as 2005, before it burst in 2008 and dragged the world into a financial crisis and a long recession.
The earnings multiples index measures the cyclically adjusted earnings multiple. That is, instead of examining the profit multiplier in the last 12 months, in relation to the past and in relation to the expected, the profit multiplier is examined in relation to the average of the last 10 years. This way we can get a picture of the last decade and ignore one-off good/bad years.
Previously, the calculation was by measuring the value of the S&P 500 index and dividing it by the average value of profitability over ten years. According to Shiller, this way the expected return on the stock market in the coming years can be predicted much more accurately. But today, analysts also use this index for analysis and research of individual companies. They are actually looking for the representative profit multiplier through the multiplier that appears in the Shiller index.
How can one know what the return “according to the book” can be received from a share according to the profit multiplier?
What is a profit multiplier? Let’s start with a demo. If the profit multiplier is 20, that means it will take 20 years “so to speak” to return the investment (as long as the company is not growing, the profits are stable). If the company is worth 200 million, and it earns 10 million a year, it will take the shareholders 20 years as mentioned to return the investment. Theoretically, if every year the company distributes its profits as dividends – 5% per year (10 out of 200), then in 20 years it will return 100% of the investment to the shareholders.
From this you can also understand why people look for the companies with the low multipliers, which can pay back their investment quickly. These are the cases where the annual return is expected to be large. But be warned – not all that glitters is gold. Low multipliers can hide trouble in the future. Investors don’t just price a company at a low-cheap multiple. And vice versa – high multiples sometimes hide accelerated growth and decreasing multiples in the future.
Multipliers different from the norm occur because many times the trading is not related-depends on the fundamentals data; Sometimes the market is influenced by hype, fashion and of course – there are significant macroeconomic consequences, including inflation and interest rates.
Shiller’s average earnings multiple (CAPE) since 1881 is 16.8. That is, if the current profit multiple is above the number in question, it means that the market is trading above its long-term average and may be overvalued. If the result is lower than the average, it means that the market is undervalued.
Despite the declines in the markets in the last six months, the Shiller index is still above the average and now stands at 28, When the dot bubble popped in 2000, before the broad declines in the markets, the index stood at 38.
This multiplier helps us calculate, in an inflation-adjusted manner, the potential return that, again, “by the book”, we should get from the S&P 500 index. A Shiller multiplier times 38? So the expected annual potential return on the Snoopy index is 2.63% per year, adjusted for inflation. At a multiple of 28 the expected return is 3.57%.
There is a bit of a contradiction here because in the last 22 years (since the dot com crisis) the S&P index has increased by 6.45 per year, much more than what the multiplier expressed at the time (2.63%) and this is due to the increase in the profits of the companies in the multiplier, and still, according to the indicator it is possible Understand if and when you need to have a selshuk and on the face of it, the index now says – expensive. Have to wait. A positive return is expected, and this is even before the increase in the companies’ profits, and it is still not what it was in recent years.
On the basis of the Shiller index, an investment scheme was developed that is based on the index. Since 2002, the method has managed to achieve a cumulative return of 775% compared to about 440% achieved by the S&P 500 index, this through cooperation with the financial company Barclays (an index called Shiller Barclays CAPE US Core Mid-Month).
So there is a slightly bearish message here, when another reason to believe this bearish message is that the same story is told by other value indices with high reliability according to history, take for example the Buffett indicator, which is the ratio between the total capitalization of the stock market and the gross domestic product (GDP). c), the value of the indicator currently stands at a very high rate, at the 97% percentile in the historical distribution. According to Buffett, the indicator is “probably the best measure of the position of the market valuations of the shares at any given moment”.