A classic price/earnings ratio is the relationship between the current share price and one year’s earnings, usually the last year, or a forecast for the year ahead.
However, the problem with using a single year is that earnings can be volatile, so the number used may not be typical in a very cyclical industry.So Yale professor Robert Shiller developed the Shiller p/e.
This uses an average earnings figure for the last ten years – roughly one full business cycle. The hope is that this gives a more representative p/e, as it is based on less of a snapshot profit figure than the classic ratios.
In all cases, however, a low p/e tends to indicate that a stock is cheap, while a high p/e suggests it is expensive.
• See Tim Bennett’s video tutorial: ‘Cape’ – Moneyweek’s favourite valuation ratio.