The Shiller P/E: In Need of a Revision?

Does the “Shiller P/E” need a revamp? Some well-known strategists say yes, but others — including Yale Economist Robert Shiller himself — say no.

While most strategists and publications use shorter-term earnings in developing price/earnings ratios, the Shiller P/E — also known as the 10-year P/E — compares a company’s average earnings over the past decade to its current price as a way to smooth out short-term earnings fluctuations. Right now, according to The New York Times, it’s at about 23, well above its historical average of about 16.

But at least two well-known strategists — Wharton professor and author Jeremy Siegel and Bank of America Merrill Lynch’s David Bianco — say the Shiller P/E can be misleading. Bianco, the Times reports, says it should include three revisions:

  • Use operating earnings instead of as-reported earnings;
  • Determine the historical average by looking only at the past 30 or 50 years or so, not the hundred-plus years Shiller uses;

  • Change the calculation to reflect the fact that companies today are keeping more of their profits than they did years ago, when more profits were paid out as dividends. Retaining and investing profits leads to faster earnings growth, he says.

Siegel agrees with the last point, and also says some of the one-time charges included in as-reported earnings should be removed from earnings calculations, the Times says.

Shiller, however, disagrees. “Mr. Shiller did his own calculation about the impact of declining dividends on earnings growth and concluded that it is marginal at best, not meriting any adjustment,” the Times reports, though it adds that he says he’ll think about Siegel’s point on certain one-time expenses being deducted from earnings calculations.

Research Affiliates’ Rob Arnott stands behind Shiller. He says he doesn’t trust operating earnings, for one thing. And he says he’s found that lower dividends don’t lead to faster earnings growth. Instead, he says, lower dividends are a sign that companies are worried about the future, or that they’re spending lots of cash on big acquisitions, which he says can limit earnings growth.

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