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What Is the Meaning of CAPE? (Part 2)

Fundamentals behind the CAPE (cyclically adjusted price/earnings ratio).

Michael Rawson, CFA 07 January, 2016 | 16:04
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In part 1 of this article, we walked through how CAPE has trended in the past. Now, let’s take a look at the fundamentals behind the CAPE.

The Fundamentals Behind the CAPE
The gradual rise of the CAPE could be owed to shifting fundamentals. The fundamentals that drive the CAPE are the same as those that underlie the P/E ratio. The P/E ratio is related to the dividend discount model, which says that the present value of a stock equals the discounted value of all future dividends. If we assume that dividends grow at a constant rate, we can simplify the dividend discount model to:

160107 CAPE 01(EN)

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About Author

Michael Rawson, CFA  Michael Rawson, CFA is an ETF Analyst with Morningstar.

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