Quantitative Value Research: Cyclically-adjusted P/E (CAPE) Factor

/Quantitative Value Research: Cyclically-adjusted P/E (CAPE) Factor

Quantitative Value Research: Cyclically-adjusted P/E (CAPE) Factor

By | 2017-08-18T16:58:18+00:00 October 3rd, 2014|Research Insights, Value Investing Research|7 Comments

Stock Prices, Earnings, and Expected Dividends

Core Idea:

Price-earnings ratios and dividend-price ratios are useful for forecasting future stock price changes.

  • The core premise is that valuation ratios will fluctuate within their historical ranges in the future; when a ratio is at an extreme level, it will mean revert, and either the numerator or the denominator are forecastable.
  • Dividend-price ratios are a poor predictor of future dividend growth (R-square = 0.25%); however, dividend-price ratios are a much stronger predictor of future real price changes (R-square = 63%).
  • Price-smoothed-earnings ratios also have special significance.

Alpha Highlight:

Faber (2012) applied this valuation metric across more than 30 foreign markets and finds it both practical and useful. Below are two charts from Faber (2012).

2014-10-02 10_53_04-0Value Reseach Recap.pptx - Microsoft PowerPoint (Product Activation Failed)

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

2014-10-02 10_54_15-0Value Reseach Recap.pptx - Microsoft PowerPoint (Product Activation Failed)

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.


  • The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).
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About the Author:

Wes Gray
After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.
  • Paul Novell

    A CAPE country ETF ranking tool/screen would a useful addition to your DIY Quant section.

  • great idea!

  • Doug

    Seconded.

  • Sam Y

    This makes me wonder about Alpha Architect QV real 10-year CAGR vs 10-year Shiller PE. Have you looked at that?

  • Hey Sam,
    We try and avoid directly talking historical performance about QV. All I can say is that 10-year Shiller P/E–as a security selection device–is not the best tool in the toolkit.

  • Sam Y

    Thanks!

  • Doug01

    About using CAPE to stock pick, in your book “Quantitative Value”, you found that it didn’t help. I’m reading Behavioural Investing” by James Montier. He does a similar analysis using the MSCI World Index from 1980-2005. At the start of each year, deciles were formed and their performance measured over the next 12 months. Negative PEs were excluded, and cyclically adjusted PEs below 1 were excluded. If a company didn’t have a full set of earnings, they computed the PE based on the maximum amount of data that was available. Stocks were held for one year, and there was annual rebalancing. If you chose the cheapest decile based on last year’s trailing PE, you outperform by 5.5%. But if you average the last 3 years earnings, you outperform by 10%. They also looked at averaging the last 5 years (11% outperformance), 7 years (12%) and 10 years (13%)