What’s the difference between the PE ratio and the CAPE ratio?

Julie Brownlee, Fsp Invest, 23 Sep. 2015

Tags: pe ratio, cape ratio, financial ratios, what is the pe ratio, what is the cape ratio,

One of the most cited financial ratios in the investment world is the price earnings (PE) ratio. But if you’ve done some digging, you may have come across the cyclically adjusted price earnings (CAPE) ratio.

So what is the difference between these two ratios? And how should you use them?

Let’s take a closer look…

The definitions of these key financial ratios

The PE ratio is the current price of a share divided by its most recent earnings per share. The PE ratio will change as the share price fluctuates.

A low PE ratio suggests a share is cheap, whereas a high PE ratio suggest a share is expensive.

The CAPE ratio, on the other hand, takes the PE ratio a step further. Robert Shiller, a Nobel Prize winner, is behind the ratio.

To calculate the CAPE ratio, you need to look at ten years’ worth of earnings and take the average. You then take the current share or market price and divide it by the earnings.

The idea behind the CAPE ratio is you can use it to see if it’s a good time to buy by comparing a market or a share to its long-term performance.

It smooths out the busts and booms of the market over time.

How to use these financial ratios when you invest

The PE ratio is a useful and readily available ratio. It’s a good starting point in your research, but you can’t rely solely on it. As is the case with all other ratios, it’s best to use them in conjunction with other ones.

For instance, if you’re a value investor, you may find stocks with low PE ratios. This gives you a list of stocks to start delving deeper into, looking for reasons why they’re trading on low PEs.

The CAPE ratio is also useful, but chances are you’ll have to work it out yourself. It’s a good comparison tool. You can compare the current PE with the CAPE ratio to give you an idea of how a company stands against its longer-term performance.

So there you have it. The difference between the PE ratio and the CAPE ratio.

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