The CAPE ratio, also called the Shiller P/E, measures how expensive a stock index is by dividing its current price by the average of its inflation-adjusted earnings over the previous ten years. The ten-year window smooths out the booms and busts that distort a standard price-to-earnings reading. The S&P 500’s long-term CAPE average sits around 17, and as of late 2025 it hovered near 37, roughly double that historical norm. Whether that gap signals danger or reflects a changed economy is one of the most contested questions in investing right now.
How the CAPE Ratio Is Calculated
The formula is simple. Take the current, inflation-adjusted price of a broad stock index like the S&P 500, then divide by the average of that index’s inflation-adjusted earnings per share over the previous ten years. The result tells you how many dollars investors are paying for each dollar of smoothed, real earnings.
The inflation adjustment is what separates this from a napkin calculation. Each year’s earnings figure gets restated in today’s dollars using the Consumer Price Index.1U.S. Bureau of Labor Statistics. Consumer Price Index Without that step, a dollar earned in 2016 would look identical to a dollar earned in 2026, even though inflation has eroded its purchasing power. Once every year in the decade is converted to real terms, you take the simple average. That average becomes the denominator.2Invesco. Applied Philosophy: The Shiller PE and S&P 500 Returns Revisited
Why ten years? Because that span captures at least one full business cycle. A single year’s earnings can spike during a boom or crater during a recession, and either extreme distorts a valuation snapshot. Averaging across expansion and contraction gives you something closer to the economy’s sustainable earning power. Robert Shiller developed this approach at Yale, drawing on ideas that trace back to Benjamin Graham and David Dodd’s work on security analysis in the 1930s.3Robert Shiller. Online Data – Robert Shiller
The Total Return CAPE
A refinement called the Total Return CAPE, or TR-CAPE, adjusts for the fact that American companies have shifted heavily from dividends toward share buybacks over the past few decades. The standard calculation ignores what happens to dividends after companies pay them, so it can overstate how expensive the market looks compared to earlier eras when payout ratios were higher. The TR-CAPE corrects this by reinvesting dividends back into the price index and scaling earnings per share accordingly.3Robert Shiller. Online Data – Robert Shiller The gap between the two versions is modest, but serious researchers check both.
What the Numbers Actually Mean
The S&P 500’s CAPE has averaged roughly 17 across its history stretching back to 1881. Near that level, the market is priced more or less in line with what investors have historically paid for long-term earnings. The further above 17 the ratio climbs, the more optimistic the market’s pricing becomes.
Extreme readings have a track record of appearing at memorable turning points. During the dot-com bubble, the ratio peaked at roughly 44 to 45 in late 1999 and early 2000, essentially pricing in decades of uninterrupted profit growth that never materialized. At the opposite extreme, during the depths of the Great Depression and again in the early 1980s, the ratio fell into single digits. Those turned out to be extraordinary buying opportunities.
Here is the catch. A reading above the historical average does not mean a crash is coming. Since 1996, the U.S. CAPE has been above its long-term average roughly 96% of the time.4Research Affiliates. CAPE Fear: Why CAPE Naysayers Are Wrong If you had sold every time it looked expensive by 1990s standards, you would have missed enormous gains. The ratio is a long-range lens, not a traffic signal.
How CAPE Differs From the Standard P/E Ratio
The standard price-to-earnings ratio uses the most recent twelve months of reported earnings. That makes it responsive to current conditions, which sounds like a virtue until you see the blind spot. During a boom, corporate profits hit record highs, the P/E denominator inflates, and the ratio drops. The market looks cheap precisely when it may be most overextended. The reverse happens during recessions: earnings collapse, the standard P/E spikes, and stocks look expensive at the exact moment prices may actually represent good value.
The CAPE’s ten-year averaging neutralizes this trap. Because the denominator blends peak and trough earnings, it does not get fooled by where you happen to sit in the business cycle. In the late stages of an expansion, you will often see the standard P/E staying flat or falling while the CAPE climbs steadily. That divergence is the signal: current earnings are running well above their sustainable trend.
The trade-off is timeliness and scope. The standard P/E reacts quickly to earnings surprises and can be useful for evaluating individual companies over shorter horizons. The CAPE moves slowly and was designed for broad market indices, not individual stocks. Applied to a single fast-growing company, it produces misleading results, because ten-year average earnings badly understate what the company earns today. A firm growing earnings at 13% annually will have current profits roughly a third above its decade average, making its CAPE look wildly expensive even if its current-year P/E is reasonable.
Why Interest Rates Change the Reading
One of the most common mistakes investors make is treating 17 as a fixed fair value regardless of the interest rate environment. That average was built from a period that included double-digit Treasury yields in the early 1980s and near-zero rates in the 2010s. The rate environment matters because stocks compete with bonds for investor capital. When bonds pay very little, investors rationally accept lower earnings yields on stocks, which pushes P/E multiples higher.
Shiller addressed this by introducing the Excess CAPE Yield, or ECY. The formula inverts the CAPE ratio to get an earnings yield (1 divided by CAPE), then subtracts the real 10-year Treasury yield.5Morningstar. Another Perspective on Stock Prices The real yield means the nominal Treasury rate minus the average annualized inflation rate over the prior decade. If the CAPE is 36, the earnings yield is about 2.8%. Subtract a real 10-year Treasury yield of 1.5%, and you get an ECY of roughly 1.3%.
The ECY tells you how much extra compensation stocks offer over risk-free bonds after adjusting for both cyclical earnings distortions and inflation. A CAPE of 30 in a world of 1% real rates looks very different from a CAPE of 30 when real rates are 4%. The raw number treats both situations identically; the ECY does not. If you plan to make portfolio decisions based on valuation, the ECY is a more complete signal than the raw ratio alone.
What You Can Actually Do With It
Set Realistic Long-Term Return Expectations
The CAPE’s strongest empirical support comes from forecasting returns over the next decade or longer. The relationship is inverse: the higher the CAPE when you buy in, the lower your subsequent returns tend to be. The predictive power consistently improves as the time horizon stretches from one year to five to ten. In practice, an investor entering the S&P 500 at a CAPE of 35 should temper their return expectations compared to someone buying in at a CAPE of 15. That tells you nothing about next quarter, but it shapes how much to allocate to equities versus bonds over a retirement horizon.
Compare Markets and Sectors
The ratio becomes especially useful across countries or sectors. If the U.S. market carries a CAPE near 37 while emerging market indices sit around 12, the valuation gap suggests the potential return runway is longer abroad. Plenty of investors use these comparisons to tilt portfolios toward regions where prices look more reasonable.
Sector-level CAPE ratios show just as much dispersion. As of late 2025, the information technology sector’s CAPE stood near 64, while healthcare sat around 25 and the overall U.S. benchmark was roughly 38.6Morningstar. Is It Time to Sell Your Tech Stocks and Reinvest Elsewhere? A single “market is expensive” headline hides the fact that tech valuations are doing most of the heavy lifting while other sectors trade at far more modest multiples. Comparing a sector’s current CAPE to its own history is more informative than comparing it to the broad market average of 17, which blends vastly different business models.
Guide Allocation Decisions
Some institutional managers use CAPE levels as a systematic input for adjusting equity exposure. When the ratio signals significant overvaluation, they trim stock weightings and lean toward bonds or cash. When it falls well below the historical average, they add equity exposure. This kind of rules-based approach imposes discipline during periods when sentiment runs hot or cold. The key word is input, not trigger. No serious portfolio manager sells everything because a single metric flashes red.
Where the CAPE Ratio Falls Short
It Is Not a Timing Tool
The most important caveat first. Research Affiliates put it plainly: “The CAPE ratio is not a useful timing signal for market turning points, but is a powerful predictor of long-term market returns.”4Research Affiliates. CAPE Fear: Why CAPE Naysayers Are Wrong The ratio can stay elevated for years while the market keeps climbing. Selling because the CAPE looks high on a one-year horizon is a recipe for regret. Over short periods, capital flows, momentum, and sentiment dominate valuation.
Accounting Rules Have Changed
The ten-year window blends data from different accounting regimes. The biggest shift came in 2001, when new rules required companies to test goodwill and other long-lived assets for impairment annually rather than amortizing them slowly over decades. During recessions, this creates massive one-time write-downs that crush reported earnings in ways that did not happen under the old rules. The fourth quarter of 2008 saw write-downs large enough to nearly wipe out the entire index’s earnings for the period. Pre-2001 earnings were never subjected to these harsher standards, so direct comparisons between today’s CAPE and readings from the 1970s or 1980s are not quite apples to apples.
The Market Itself Looks Different
The S&P 500 of 2026 looks nothing like the S&P 500 of 1960. Technology companies with high margins, low capital requirements, and fast earnings growth now dominate the index. By the end of 2020, the ten largest companies accounted for over 30% of the index’s market capitalization, up from less than 20% a decade earlier.7MDPI. Why the High Values for the CAPE Ratio in Recent Years Might Be Justified These firms command higher P/E multiples than the industrial conglomerates and utilities that dominated earlier eras, and their earnings growth rate over 2010 to 2019 ran roughly double the historical average. One academic estimate suggested that after accounting for these structural shifts, a CAPE near 30 could be considered fairly valued for the modern index rather than dangerously expensive.
Dividends Gave Way to Buybacks
American corporations have gradually replaced dividends with share buybacks as the preferred way to return cash to shareholders. Because lower payout ratios mean more retained earnings, and retained earnings fuel faster per-share earnings growth, the CAPE has a subtle upward bias compared to earlier decades. Shiller has acknowledged this criticism but described its actual impact on the ratio as “marginal at best.” The Total Return CAPE was designed in part to address it.
How to Use the CAPE Ratio Without Misusing It
The CAPE ratio works best as one lens among several. It excels at framing long-term expectations and flagging when the market’s price tag has drifted far from historical norms. It falls short as a short-term signal, struggles with individual stocks, and needs to be read alongside interest rates to avoid false alarms. When the ratio runs at twice its long-term average, the right response is not panic. It is a harder, more honest look at your return assumptions and how much risk your portfolio can actually carry.