The price earnings ratio is calculated by dividing a company's stock price by it's earnings per share. In other words, the price earnings ratio shows what the market is willing to pay for a stock based on its current earnings. The PE ratio of the S&P 500 divides the index by average eranings of the trailing twelve months. In 2009 when earnings fell close to zero the ratio got out of whack. A solution to this phenomenon is to divide the price by the 10-year average of earnings. In recent years, Yale professor Robert Shiller, the author of Irrational Exuberance, has reintroduced this adjusted ratio to a wider audience of investors. The Shiller PE Ratio of the S&P 500 is illustrated below.
Instead of dividing by the earnings of one year (see chart above), this ratio divides the price of the S&P 500 index by its average inflation-adjusted earnings from the previous 10 years. The ratio is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio), the Shiller PE Ratio, or the P/E10.
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