US Stock Market Valuation

Total Return CAPE Ratio

Prof. Shiller addressed the criticism of traditional CAPE ratio, that changes in corporate payout policy, such as share repurchases instead of dividends as dominant approach in the USA for cash distribution to shareholders, which can affect the growth rate and the average of the real earnings per share used in the CAPE ratio, by develping a Total Return CAPE, which corrects this bias by reinvesting dividents into the price index and properly scaling earnings per share.

Total Return EPS tells us what earnings would have been if the dividend payout ratio had been 0% at all times. This way, it reduces all earnings data across all periods of history to the same common basis, allowing for accurate comparisons between any two points in time.

Total Return CAPE is used as a valuation metric to forecast future returns, where a higher CAPE ratio could reflect lower returns over the next couple of decades, whereas a lower CAPE ratio could reflect higher returns over the next couple of decades, as the ratio reverts back to the mean.

Buffett Indicator

The Buffett Indicator is the ratio of total United States stock market valuation to GDP.

The most common measurement of the aggregate value of the US stock market is the Wilshire 5000.

Buffett indicator greater than 1.0x (or 100%) is generally considered a sign of being overvalued, while indicator below 0.5x (or 50%) is considered to be undervalued.