Real earnings per share (EPS) over a ten-year period are used in the CAPE ratio, a valuation metric, to smooth out variations in company profits that happen at various points in a business cycle.
Cyclical adjusted price-to-earnings ratio is referred to as the CAPE ratio. Additionally called the Shiller P/E ratio. The P/E ratio is a measure of stock valuation that compares the price of a stock to its earnings per share. EPS is calculated by dividing a company’s profit by its outstanding equity shares.
Numerous economic cycle effects have a substantial impact on a company’s profitability. Consumer spending increases during expansions, which boost profits significantly, but consumer spending decreases during recessions, which can result in losses.
Few businesses can maintain consistent profitability in the face of a severe recession, even though profit swings are much larger for businesses in cyclical sectors—such as commodities and financials—than they are for businesses in defensive sectors. These sectors include utilities and pharmaceuticals. Because of the volatility in per-share earnings, price-earnings (P/E) ratios are likewise volatile.
CAPE ratio= Share price/ 10−year average, inflation−adjusted earnings
The CAPE ratio is criticized for being fundamentally backward-looking rather than forward-looking, which they claim makes it not very effective.