CAPE: How to find out if shares are really cheap or expensive

Julie Brownlee, Fsp Invest, 19 Aug. 2014

Tags: cape, what is cape, cyclically adjust price earnings ratio, pe ratio, financial ratio, how to find cheap shares,

The price earnings (PE) ratio is one of the most cited financial ratios. It can be a handy ratio to use, but it has its shortfalls.

The good news is, there’s a modified version of the PE ratio. This deals with some of the issues with the PE ratio.

So what is this other ratio?

Read on to find out…

The problem with using the PE ratio

One of the easiest and quickest ways of valuing a company is to look at its PE ratio. You can calculate a company’s PE ratio by dividing its current share price by its latest or forecast earnings per share (EPS).

You can also look up the PE ratio of a share on a host of online financial sources.

The major issues around using the PE ratio is that as it uses a company’s current profit level (earnings), this might not be a true reflection of what goes on within a company apart from the year you’re looking at.

This can be problem when you look at companies in cyclical sectors. For instance, manufacturing companies and airlines.

Profits in these companies tend to move about according to what’s going on in the economy. So you could misinterpret the PE if the earnings used aren’t a true representation of what’s going on in a business over the long-term.

For example, shares in a construction company might look cheap when you look at its PE ratio during a boom time in infrastructure. But if a recession follows, a construction company’s profits will fall too.

So this is where this modified PE ratio comes in…

What is CAPE?

CAPE is the cyclically adjusted price earnings ratio. To use CAPE, you average out a company’s profits over a number of years. Usually anything from seven to ten years.

By taking an average, it takes into account any economic ups and downs. To put it another way, you adjust the PE ratio to take into account what’s going on in the economy.

To calculate CAPE, you take a company’s share price and divide that by its average earnings per share.

CAPE is a great way of checking if a company is really cheap or expensive compared to what’s gone on with its profits over the long-run.

So there you have it, how to find out if shares are really cheap or expensive with the CAPE ratio.

*********** Advertisement ************

One special type of investment has proven itself to be the safest way to grow your money – in any environment

Time and time again dividend-paying stocks have proven to be among the safest, most stable stocks around.

They’re virtually bulletproof. Or, to be more precise, they’re “rand-proof.”

And that’s why I’ve picked out the top four dividend payers that are virtually guaranteed to outperform the market in 2014 and beyond.

And all you need to do to get your hands on these hot stocks is purchase my all new report…


Related QA

d.c.heger asked:
MY QUESTION IS – I bought Bitcoin & Etherium some time ago – at first they grew nicely but now they are lower than what I paid for them. Should I [read more]
Published at 04 Apr. 2018 in: Investing 5 shares due to rocket 1 Answer
kavesh.maharaj.73 asked:
Hi Josh. I would like some advice on TFSA. I can get an interest rate of 7.8% nominal at a bank if I invest the R33k upfront in a fixed deposit [read more]
Published at 19 Mar. 2018 in: Investing Tax free savings vehicle 2 answers
kavesh.maharaj.73 asked:
Hi Josh Quantum wants to buy back shares from shall investors at what I think is a low price of around R3.86. You tipped the share in February [read more]
Published at 14 Mar. 2018 in: Investing Real wealth 5 answers
elizastrydom asked:
Hi Timon I am interested in registering for your Red Hot Storm Trader service. I am already a Red Hot Penny Shares investor. My question is [read more]
Published at 28 Feb. 2018 in: Investing Trading platform and broker 1 Answer
ManuE asked:
I have an interest in investing in Bitcoin, I just don't know how. If I buy Bitcoin with R15 000, how much can make (Return On Investment)? [read more]
Published at 25 Feb. 2018 in: Investing Investment 1 Answer

Related articles:




Youtube Twitter Facebook

Connect with us:    

  • Accelerated Investor