One of the best measures for whether stocks are over- or undervalued is the famous “cyclically adjusted price/earnings” ratio, or CAPE, developed by Yale professor, and Nobel laureate, Robert Shiller. The CAPE’s main contribution is adjusting for times when earnings are either enjoying an unsustainable boom, or stuck in a temporary rut. Indeed, the high volatility of corporate profits tends to distort P/Es as reported. A huge surge in EPS that’s bound to fade when heightened competition restores margins to traditional norms artificially swells the denominator. That lowers P/Es measured at a single point in time, and makes shares look a lot cheaper, or less overpriced, than they really are.
In early July I wrote about what Apple’s formidable P/E of 33—double the number in the mid-to-late 2010s—signals for its future returns. The scale of that multiple, and the gap between Apple’s booming stock price and its staid fundamentals, I asserted, are actually understated for a basic reason: Its recent earnings are so gigantic versus most of its recent history that they’re more likely to stagnate or drop than rise rapidly from here.
Hence, you’d get a much more realistic estimate of what Apple’s providing in dollars of profit for every $100 spent on its stock by using not today’s inflated EPS, but a metric for bedrock, repeatable earnings. And that’s just the formula the CAPE provides. It deploys not current results, but a 10-year average of EPS, marking up past years for inflation.
What the CAPE tells us about Apple. It’s scary
Shiller calculates the CAPE only for the entire S&P. Right now, it’s 30.9, extremely high compared to the long-term averages. But where is Apple? I ran the numbers. In FY 2013 (ended September 30), the iPhone maker notched $1.82 in inflation-adjusted EPS, doubling the figure to $3.75 in 2020. Over the next 12 months, profits exploded, jumping 62% to $6.08 in FY 2021, and surmounting 8% inflation to beat that level in 2022 at $6.11.
Averaging the past decade of profits, updated for inflation, yields a CAPE EPS of $3.15. Divide that $3.15 into its share price of $192 on July 5, and you get the Shiller P/E of 61. This number, to put it mildly, is big. The highest CAPE ever recorded for the S&P was 44, set during the dotcom bubble in mid-1999. It’s also double the present elevated CAPE for U.S. big caps.
How realistic is the CAPE in assessing whether Apple is hugely expensive?
On paper, Apple’s CAPE of over 61 puts it in the super-priciest of realms. But Apple is a special case. The pandemic clearly created a fresh liftoff for its products and services, some of which will retain its power. Still, it’s unlikely that Apple’s $100 billion in total earnings and over $6 in EPS notched in 2022 form a new, solid launch pad. Its quarterly profits have been declining since mid-2022, indicating that at least part of the COVID rocket ride was a one-time phenomenon.
A reasonable view is that the CAPE of over 60 is too high and exaggerates how overpriced Apple really is. But its current multiple of 33, high though it is, doesn’t tell the full story either. The Shiller P/E math suggests that we should sharply discount Apple’s current, and already falling, profits to get an accurate picture of the price you’re paying versus the earnings it can consistently deliver. Even if we assume that profits will trend downward to $5, still almost 70% over pre-pandemic levels, what you’re really paying now is more like 40 times base earnings.
The Shiller P/E doesn’t tell us everything, and in the Apple example, that gigantic multiple of 61 is misleading. But it tells us a lot, and this time-honored metric shows that a realistic reading dwarfs the official P/E that’s already flashing red.
This article is part of Fortune’s quarterly investment guide for Q3 2023.