What is P/E 10 Ratio?
762 reads · Last updated: December 5, 2024
The P/E 10 ratio is a valuation measure generally applied to broad equity indices that use real per-share earnings over 10 years. The P/E 10 ratio also uses smoothed real earnings to eliminate the fluctuations in net income caused by variations in profit margins over a typical business cycle. The P/E 10 ratio is also known as the cyclically adjusted price-to-earnings (CAPE) ratio or the Shiller PE ratio.
Definition
The Price-to-Earnings Ratio 10 is a valuation metric typically applied to composite stock indices, using the actual earnings per share over the past 10 years. It smooths actual earnings to eliminate fluctuations in net income caused by profit margin changes during typical business cycles. The P/E 10 is also known as the Cyclically Adjusted Price-to-Earnings (CAPE) ratio or Shiller P/E.
Origin
The concept of P/E 10 was introduced by economist Robert Shiller, who developed this metric while studying market valuations and long-term investment returns. The origin of the Shiller P/E can be traced back to the late 1980s and early 1990s when Shiller collaborated with John Campbell to research long-term stock market returns.
Categories and Features
P/E 10 is primarily used to assess the overall valuation level of the market rather than individual stocks. Its feature is the use of a 10-year average of earnings to reduce the impact of short-term earnings volatility, providing a more stable valuation benchmark. The advantage of P/E 10 is its long-term perspective, helping investors identify overvalued or undervalued market conditions. However, its disadvantage is that it may not reflect rapid market changes promptly.
Case Studies
A typical case is during the 2000 dot-com bubble when the P/E 10 reached historical highs, indicating market overvaluation. The subsequent market crash validated the warning sign of the P/E 10. Another case is after the 2008 financial crisis, where the P/E 10 showed the market was undervalued, and the market gradually recovered, offering good investment opportunities.
Common Issues
Common issues investors face when using P/E 10 include how to deal with changes in P/E 10 under different market conditions. The P/E 10 does not always accurately predict market trends as it is a long-term indicator and may not reflect short-term market fluctuations. Additionally, investors might misunderstand the high or low levels of P/E 10, requiring a comprehensive analysis with other indicators.
