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A new and improved Shiller P/E

www.macrobusiness.com.au
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Last week I dealt with the less controversial changes to the Shiller P/E. You probably want to read that first. In this post, I derive a more advanced version: CAPE 3.0. The main finding? If you measure it differently, the last 20 years go from being an expensive aberration to a typical investment period. Factors
Last week I dealt with the less controversial changes to the Shiller P/E. You probably want to read that first. In this post, I derive a more advanced version: CAPE 3.0. The main finding? If you measure it differently, the last 20 years go from being an expensive aberration to a typical investment period.

Factors I adjust for:

Average pretax earnings. I assume the future tax rate will be the same as a mixed U.S./International statutory rate +/- the difference over the previous 10 years in actual vs statutory. Adjust for buybacks. Adjust for changes in accounting standards. Adjust for effects during high inflation periods of overstated reported profits. Adjust for the cost of trading and spreads to reflect the after fee returns to shareholders I haven't adjusted for negative earnings. I want to see a different series that does adjust, but I don't have enough data. I haven't used Shiller's total return re-investment adjustment. I disagree with it.

See the effect below of this version of CAPE 3.0:

The net effect is not that much on the latest reading. But, these changes increase prior levels, in some cases substantially. Still expensive. But not outrageously so. And importantly, the last 20 years no longer look like an expensive aberration.

Relative to bonds, the excess CAPE 3.0 yield goes from slightly expensive to slightly cheap. Which probably says as much about bonds as it does equities:

The rest post is for those who care about the detail. It is probably too much information for most!

1. Tax detail

I'm going to start by admitting that I don't have 150 years of detailed company financials. There are a lot of estimates based on judgement. Hopefully, some enterprising students looking for thesis topics can fill in the gaps in the coming years.

In CAPE 2.0, I used statutory rates to adjust tax. There are so many minor tax issues that this seemed to be a less arbitrary adjustment.

In CAPE 3.0, I'm interpreting tax more realistically. First, we use the same…
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