CAPECrusaders:

TheShillerSiegelShootoutattheQGroupCorral
ByLaurenceB.Siegel
February18,2014
Bynow,almosteveryinvestorhasheardoftheNobelPrizewinningYaleprofessorRobertShillersstock
marketvaluationmetric,thecyclicallyadjustedpriceearnings(CAPE)ratio. 1 Thismeasureisdesignedasan
improvementonthetraditionalpricetoearnings,orP/E,ratio.Tocorrectforearningscyclicality,theCAPE
usesanaverageofthelast10yearsreal,orinflationadjusted,earningsinthedenominatorinsteadofjust
oneyears(trailingorforecast)earnings.

TheCAPEratiohasbeendiscussedinAdvisorPerspectivesbyDougShort,WilliamHester andthefamed
WhartonprofessorJeremySiegel.Inotherwords,itsquiteahottopic.

SiegelandShillermadecompetingpresentationsattheQGroupsfall2013meetinginScottsdale,Arizona,
onOct.15.(TheQGroupisadiscussiongroupofseniorinvestmentprofessionals,chieflyquants,that
organizesprestigiousconferenceswhereacademicsandpractitionersinteract.)IwishIcouldsaytheyfaced
offtheywerescheduledtobutShillerhadbeeninformedthepreviousmorningthathehadwonthe
NobelPrize,soheusedavideoconnectiontoattendremotely.Thisarticlewillreportontheirdiffering
viewsandattempttodrawsomeconclusionsaboutthemarketsprospects. 2

CAPEbasics

Figure1showstheevolutionoftheCAPEratiofrom1881to2014.Byhistoricalstandards,theCAPEratio
todayisquitehigh,around25.Thatis,theS&P500ispricedat25timesthe10yearaverageofreal,
trailing,reportedearnings.Thisratioisabout50%aboveitshistoricalaverageandisconsideredbymany
analysts,includingShillerhimself,tobeindicativeoflowexpectedreturnsfromthispointforward.

AlsocalledtheShillerP/EorPE10.

ShillerdidnotresponddirectlytoSiegelbutmadearelatedpresentationoncurrentvs.historicalvaluationofequity
marketsectorsandindustries.OnemustadmitthatShillersNobelexcusefornotshowingupordirectlyrebutting
Siegelwasunique.

-1 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

Figure1
CyclicallyAdjustedPriceEarnings(CAPE)ratio,January1881February2014

CurrentCAPERatio:24.99(asofcloseonFeb.10,2014)
Mean:
16.51
Median:
15.90
Min:
4.78
(Dec1920)
Max:
44.20
(Dec1999)

Source:http://www.multpl.com/shillerpe,basedondatafromRobertShillerswebpage.

Othersarenotsosure.Siegel,whosupportstheuseoftheCAPEratiomethodologyinprinciple,believes
thatthecurrentCAPEratioof25cannotbedirectlycomparedwithpastoraveragevaluesoftheratiofor
severalreasons.First,thepast10yearsstillincludetheearningscollapseassociatedwithglobalfinancial
crisis,whenS&P500quarterlyearningswentnegative.Second,realearningsgrowthacceleratedafter
1945,soitsmisleadingtocomparetodaysvaluationratioswithaveragesthatgoallthewaybackto1871
or1881.Third,accountingstandardshavechangedandresultinmisleadingdata.Fourth,largelosses
sufferedbyspecificcompaniesareaggregatedimproperlyintocapweightedindicessuchastheS&P.

InarecentpresentationatETF.comsInsideETFsconferenceinHollywood,Florida,onJan.28,Siegel
calculatedatraditional(oneyear)P/Eof17.2fortheS&P500,comparedwithamedianvalue,from1954
to2014,of16.5.Theseratiosarepricetoforward(forecast)earnings.Thereisnobubblehere,Siegel
said.

Clearly,thetraditionalP/EtellsamorebullishtalethantheCAPE.(Iamreallystrugglingtoavoidjokes
aboutbulls,bullfighters,capesandtails.)

-2 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

WhatsrightwithCAPE

AttheQGroup,SiegelbeganbysayingthatCAPEhasbeenagoodforecasterofstockreturns.Italsohasa
soundtheoreticalbasis.TheCAPEmethodologyisbrilliantandworks;thedataaretheproblem,hewrote
inthepaperhedistributedattheQGroup.VariationinCAPEhasexplainedaboutonethirdofthevariation
inactualsubsequent10yearstockreturns,averygoodtrackrecord.

TheCAPElevelof43inthespringof2000wasasignthatalongperiodofbadtimeswouldfollow.Itdid.
Today,theCAPEmethodforecastsa4.16%realreturnonstocksinthenext10years,abouttwopercentage
pointsbelowthehistoricalrealreturn.Thisdoesnotsoundlikeabearishforecasttome,butifoneis
countingonfuturereturnsbeingequaltolongrunhistoricalreturns,itwillbealittledisappointing. 3

Enigmatically,theequitytomarketcapitalizationratioisanevenbetterforecaster.Illreturntothatlater.
Infact,pricedividedbyanyscalingvariablethatis,anyvariablethatmakesitpossibletocompareprice
levelsovertimeappearstohavesomeforecastvalue.

WhatswrongwithCAPE

LetsreferbacktoFigure1.Around1991,theaverageCAPEshiftedupward,fromanaverageinthemidto
highteenstoanaverageinthelow20s.Infact,from1992to2014,theCAPEfellaslowasitslongrun
averageof16.5onlyonce,duringtheworstweeksofthe200809marketcollapse.Inotherwords,a
comparisonofthecurrenttothehistoricalaverageCAPEshowsthatitcompletelyfailedtopredictthebull
marketof200914.Whatwentwrong?

Thereareseveralpossibilities.Asimple,butunsatisfactory,answeristhatstockshavebeenoverpriced
sincetheearly1990s,exceptatbearmarketbottoms.

ThesimplestequilibriumexplanationisthatthefairvalueCAPErose.Investorsarewillingtopaymorefora
dollarofearningsthantheyoncewere,makingcurrentstockpriceshigherandfuturereturnslower.Ifthat
isthecase,theninvestorshopingtoearnhistoricalaveragereturnsonstocksinthefutureandwaitingfora
declineto(orthrough)thehistoricalaverageCAPEwillhavealongwait.Itisbettertobuystocksattodays

Myown10yearforecast,inGrinold,Kroner,andSiegel[2011],wasforstockstoprovideanominaltotalreturnof
7%.Becauseinflationatthetimewas2.4%,myimpliedrealtotalreturnforecastwas4.6%,whichisnotverydifferent
fromtheCAPEforecast.IdalsonotethatmyarticleforeshadowedSiegels(orelseweunwittinglycomparednotes).I
wrote,
ThecurrentShillerP/E,byaveraging10yearsoftrailingearnings,includesanearningscollapsein
20082009thatisalmostliterallyunprecedented;eventheGreatDepressiondidnotseeassharpa
contractioninS&Pearnings,althoughoverall[NIPA]corporateprofitsin1932werenegative.(Huge
lossesinafewlargecompanies,suchasoccurredin20082009,goalongwaytowarderasingthe
profitsoftheothercompanieswhensummedacrossanindex.)Onlythedepressionof19201921is
comparable.

-3 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

highpricesandearnasmallerequityriskpremium,thislogicsays,thantoearnreallystingyreturnson
bonds.

Anotherpossibilityisthat,asSiegelsuggests,thedatausedintheCAPEarebiasedorinconsistent.Ill
explorethatpossibilityinsomedetail.

Earningsdenominatordepressedbyadoubledipdepression

WhenoneusestheCAPEratioatanytimebetween2008and2013,thedenominator(10yeartrailing
averagerealearnings)picksuptwoearningsdepressions,boostingtheCAPEbyahugeamount.That
explainsmuchoftodayshighCAPE.Ifwetakeoutoneorbothoftheearningscrashes,theCAPEcomes
downtoamorereasonablelevel.Thosedepressionswillcomeoutin2019,whenthesecondcrashagesout
ofthe10yearhistory.Atthattime,foragivenmarketlevel,theCAPEwillfallconsiderablyandlookmore
normal.

Butinanalyzingatimeseries,wecanttakeoutthedatawedontlike.Theearningscrasheshappened,and
theycouldhappenagain.

Ordidthey?Figure2showsS&P500reportedandoperatingearningsandnationalincomeandproduct
accounts(NIPA)corporateprofitsfrom18712012.NIPAprofitsrepresenttheprofitsoftheentire
corporatesectoroftheeconomy,includingprivatelyheldbusinesses.NotethatS&Preportedearnings
plungedinthe1991recessionwhileNIPAprofitscontinuedtogrow.Then,in200203and200809,S&P
reportedearningsfellsharplywhileNIPAprofitsfellmuchless.

-4 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

Figure2
RealS&P500earningsandrealNIPAprofits,18712012

Source:JeremySiegel,TheShillerCAPERatio:ANewLook,QGrouppresentation,October2013.

Siegelattributesthedifferencetoaccountingpractices,nottorealdifferencesinperformance,and
suggeststhatNIPAprofitsaremorerepresentativeofwhatwasreallygoingonwiththecompaniesinthe
S&P500.Thatis,hebelievesthatcorporateAmericawasnotinasbadshapein200809asitappeared
fromreportedearningsnumbers.ByrecalculatingthecurrentCAPEratiousingNIPAprofits,hefindsno
overvaluationinthemarketatall.Healsofindsthatthefitbetweenforecastandrealizedreturns(onthe
S&P500)istighterwhenNIPAisusedtocalculatetheCAPEratiothanwhenearningsontheS&P500itself
areusedtocalculateit.

TheuseofNIPAstrikesmeasveryodd,becausethecorporatesectorismuchbroaderthantheS&P500.
Privatelyheldbusinesses,smallcapstocksandtheS&P500haveoftengoneinseparatedirections,with
littletosuggestthatonesetofcompaniescanbeusedasaproxyfortheother.Thisswitcherooalsosmacks
ofdataminingdidSiegelexaminemultipleseriesbeforehefoundonethatshowednostockmarket
overvaluation?ButSiegelsargumentisintriguing:

ItisparticularlypuzzlingthatthedeclineinS&Preportedearningsinthe20082009
recession,wherethemaximumdeclineinGDPwasjustover5%,wasmuchgreaterthan
-5 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

the63.4%declineinS&PsrecordedearningsintheGreatDepression,whichwasfivetimes
asdeep.InfactNIPAcorporateprofitswerenegativein1931and1932,farmoreinline
withothereconomicdata.Thesedisparitiessuggestthattherehasbeenachangeinthe
S&Pmethodologyfromlikelyunderstatingearningsdeclinesinrecessionstosignificantly
overstatingthesedeclines. 4

Fasterrealearningsgrowthafter1945

SiegelalsoobjectstocomparingthecurrentCAPEratiotohistoricalvaluesextendingbackmorethana
century,becauserealearningsgrowthacceleratedafter1945.Before1945,dividendpayoutratioswere
highandretainedearningswerelow,socompaniestendedtogrowmoreslowlythantheydotoday
(despiteGDPgrowthbeingfasterthanitisnow).Thedatasupportingtheseassertionsareinthelower
righthandcornerofFigure2.

ThislogicsaysweshoulddroptheearlieryearsincalculatingaCAPEaverage.Buttheimpactisnot
dramatic.TheaverageCAPEfrom1945to2014isonly5.6%higherthantheaveragefrom1881to2014,
andtheforecastoftheequityreturnrisesonly51basispointsperyearasaresultofthisadjustment.

Accountingstandardshavechanged

Siegelcontendsthat,duetoaccountingchangesinthe1990s,theCAPEusesdownwardbiasedearnings
data.Companiesarerequiredtowriteofflossesthatoccurwhenassetstheyholdfallinprice.Whenan
assetrisesinprice,however,theyarenotallowedtoreportthegainuntiltheassetissold,whichcould
involvealongwait.InthewordsofGMOsJamesMontier,goodwillaccountingmisseshalfthedata. 5 This
biascausestheCAPEtobehigherandtheforecastequityreturnlowerthantheywouldbewith
symmetricalorunbiasedaccounting.

ThemuchgreatervolatilityofreportedearningsinFigure2,ascomparedwithoperatingearnings(shown
from1989to2012),suggeststhatthisconcernisvalid.

Theconcernovergoodwillaccountingwouldbelessseriousifaccountingstandardshadbeenconsistent
overthetimeperiodforwhichthehistoricalaverageCAPEiscalculated.Wewouldbecomparingabiased
CAPEtodaywithasimilarlybiasedCAPEinthepast.Butbecausetheaccountingchangewasfairlyrecent,
theCAPEaverageincludesmanydecadeswhenaccountingwaslessconservative,causingreported
earningstobehigherthantheywouldbeundertodaysstandards.Thisphenomenonismeticulously
documentedbyanunsigned(butveryskilled)essayistatthePhilosophicalEconomicsblog,whomIquotein
violationofAdvisorPerspectivesstandardagainstcitingunsignedwork:

JeremySiegel,TheShillerCAPERatio:ANewLook,QGrouppresentation,October2013,pp.78.

JamesMontier,WhatWorriesMeRightNow,AdvisorPerspectives,February4,2014.MontierdisagreeswithSiegels
findings.

-6 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

Now,[FinancialAccountingStandardor]FAS142maybeamoreaccurateaccounting
standardthanitspredecessor,butthatisnttheissuefortheShillerCAPE.Theissueforthe
ShillerCAPEisthattheaccountingstandardisnotbeingappliedconsistentlyacrosstime.
NoneofthereportedearningsnumbersusedintheShillerCAPEforyearsbefore2001
wereheldtotheharshstandardofFAS142.Butallofthereportedearningsnumbers
usedinthemetricforyearsafter2001wereheldtothatstandard.Consequently,any
comparisonbetweenthepresentvalueofthemetricandpre2001valuesisacomparison
betweeninconsistentlymeasureddatapoints.Thepresentvaluesenduplookingmore
expensiverelativetothepastthantheyactuallyare.

Youmightthinkthattheseaccountingchangesarentabigdeal.Buttheyreahugedeal.

Howhuge?WritedownsbyS&P500companiesin2008amountedto$301billionenoughtobumpupthe
CAPEbyafullpoint,justfromthatyear.Adduptheeffectsoveradecade,anditreallymakesadifference
totheCAPEcalculation.

Lossesdontreachacrosscompanies

Finally,Siegelarguesthatreportedearnings,andbyextensionCAPE,handlelargelossesbyindividual
companiesinawaythatismisleadingwhenaggregateduptotheindexlevel.Thisaggregationbiasis
difficultforsometounderstand.Siegeldoesamasterlyjobofexplainingit:

Thisbias[comesfrom]thelargelossesofafewfirmsdominat[ing]aggregatedata.TheS&P
methodologyaddsgainsandlossesofeachS&P500[company]togethertocomputethe
aggregateearningsontheindexandthen[divides]thesumofalltheearnings[into]the
sumofallthevaluesoftheindividualstocks[toarriveataPEratio].Thisisidenticaltohow
onewouldvalueasinglefirmwith500divisions,eachdivisionreportingitsprofitsand
losses.

Butthismethodologyunderstatesthevaluationofaportfoliothatcontains500separate
firms.Financetheorystatesthatthevalueofastockisanoptiononthevalueofthefirm.
[T]hesumofthevalue[s]ofthe500[separate]optionsonthevalueofeachfirm,whichadd
uptothemarketvalueoftheS&P500,mustexceedthevalueof[an]optiononthe
earningsofasinglefirmwith500divisions.Thisisbecausethevalueofanindividual
stockcannevergobelowzeronomatterhowgreatthelossessincetheselossesareborne
byotherstakeholders(suchasbondholders)andnotbytheequityholdersofotherfirms.

Theaggregationbiaswasparticularlyacuteinthelastrecession.Theunprecedented$23.25
[pershare]lossinreportedearningsforS&P500firmsinthefourthquarterof2008was
primarilycausedbythehugewritedownsofthreefinancialfirms:AIG,Citigroup,and
BankAmerica.AIGrecordeda$61billionfourthquarter2008loss.AlthoughAIGhada
weight[of]lessthan0.2%intheS&P500indexatthetime,thislossmorethanwipedout
thetotalprofitsofthe30mostprofitablefirmsintheS&P500inthatquarter,firmswhose
-7 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

marketvaluescomprisedalmosthalftheindex. 6

Whenafewfirmsreporthugelosseswipingouttheprofitsofhundredsofotherfirmsattheindexlevel,
theaggregationbiasislarge.ItneedstobetakenintoaccountwheninterpretingtheCAPE,thetraditional
P/Eratioandindexaggregateearningsnumbersingeneral.

DefendingtheShillerCAPE

WhileShillerhasnotspecificallyrespondedtoSiegelssuggestedrevisionsoftheCAPEratio,thepure
ShillerCAPEhasattractedachorusofpassionatedefenders.ToclarifytheviewthattheCAPEindicatesan
overpricedmarket,IrelyprincipallyonDougShortandWilliamHester,referencedearlier,andonCliff
Asness,whosearticle,AnOldFriend:TheStockMarketsShillerP/E,appearedinlate2012.(Iespecially
recommendAsnesstoreaderswhoenjoychucklingatthelatestfadsinsloppyinvestmentthinking,which
heskeweredinhisrecentFinancialAnalystsJournalarticle,MyTopTenPeeves.)

First,SiegeltriesawfullyhardtogettheCAPEratiodownandtheexpectedreturnonthestockmarketup.
Allofhisadjustmentsareinthesamedirection.AcynicmightregardSiegelsadjustmentstoCAPEaspart
ofalifelongattempttoportraywhateverinformationisavailableasbullish.(Tohiscredit,Siegelturned
bearishinthelate1990sandforecastafuturereturnmuchlowerthanthehistorical. 7 )

Whileitstemptingtotakeouttheearningscrashof200809andrecalculatetheCAPEtogetamore
balancedview,DougShort,writinginAdvisorPerspectivesonFeb.3,says:

[Inplaceoftheactualdata]I'veusedtheDecember2007[trailing12month]earningsof
66.18asaconstantforthenext29monthstototallyeliminatethecollapseinearningsof
theGreatRecession.

Whatimpactdoesthishaveonthe[CAPE]?Themean(average)onlydropsfrom16.5to
16.4.Thelowerboundofthetopquintiledropsfrom20.9to20.6.Insteadofa[CAPE]of
24.9attheendofDecember,the"nocrash"versionwouldstillbeinthetopquintileat
22.6.That's37%abovethemeaninsteadof51%abovemeanwiththeauthenticdata.

ThebiasinthewayFAS142treatswritedownscanbeeliminatedbyusingoperatingearningsormaking
somesimilaradjustmentthatlessenstheimpactofthewritedownsontheCAPEratio.However,Asness
warnsthatoperatingearningsareearningsbeforedeductingbadthings.Badthingshappentogood
companies(aswellasbadones)andneedtobereflectedinproperaccounting.Thereisperilinsimply
removingbadthingsfromthedata.

JeremySiegel,TheShillerCAPERatio:ANewLook,QGrouppresentation,October2013,pp.1112.

Siegel,Jeremy.TheShrinkingEquityPremium.JournalofPortfolioManagement,Fall1999,pp.1019.

-8 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

Finally,Shillerssupportersarguethatametricshouldbeevaluatedaccordingtoitspredictivepower.It
doesnothavetobelogicallyperfectineverydetail.Thisisnottosaythereisneveraprocessswitch,or
transitionfromaperiodwhereonemodelworkstoaperiodwhenanothermodelisbetter,butthe
presumptionshouldnotbethatthistimeisdifferent.Hesterwrites,

DespitethevariousargumentsanddefensessurroundingtheCAPE,theevidenceis
perfectlyabletospeakforitself.[Aversionthat]adjuststhegrowthrateofearnings,
basedontheShillerprofitmargin,[hasa]correlationwithsubsequentreturns[of]over
90%inhistoricaldata.

Itsworthnotingboththegeneralaccuracyandtheoccasionalerrors.Atpointswhere
actualsubsequent10yearreturnsdeviatedfromthe10yearreturnsthatwereexpected,
thereasonwasthatthemarkethadreachedveryhighlevelsorverylowlevelsofending
valuation.Actual10yearreturnscameinbelowtheexpectedreturnsin1936and1964
becauseofhowundervaluedthemarketbecamein1946and1974.The[opposite]istrue
for1990and2003[becausethemarketpricelevelwashighin2000and2013].

TheCAPERatioisdoingexactlywhatithasalwaysdone,whichistohelpinvestors
anticipatetheinvestmentreturnstheyshouldexpectoverthenextdecade.Thosereturns
willverylikelybeinthelow,singledigits.

Whosright?

WhiletheCAPEratiohasalltheflawsSiegelidentifiesandprobablysomeothersthatpointintheopposite
direction,itstillgivesaforecastofrealequityreturns 8 thatisnotoutoflinewithlongtermequilibrium
expectations.Thissuggeststhatthemarketisnotallthatoverpriced.Asameasureoflongterm
equilibrium,Iusemyownrealreturnestimateof4.6%,writtenupinGrinold,Kroner,andSiegel(2011). 9
(Becausethislatterestimatewasproducedin2011,whenthemarketwaslower,anupdatedestimate
wouldalsobelower,perhapsquiteclosetothe4.16%CAPEforecast.)

Arealequityreturnalittleabove4%isnotbad.Itslowerthanthehistoricalaveragereturn,muchofwhich
wasproducedinthefabuloussecondhalfofthe20thcenturywhentheUnitedStatesachieveditsdominant
positionintheworldeconomy.Itisreasonabletothinkthatsuchhighreturnswillnotberepeated.
Investorsneedtobudgetforlowerreturns.

Thus,itsnotnecessarytoadjustCAPEinthemanywaysrecommendedbySiegeltogetreasonablestock
marketforecasts.Manyofhisadjustmentsarejustified,andtotheextentthattheyproducehigher

Siegel[2013],page3,infootnote3.CliffAsnessgetsalowernumber,basedonahistoricalanalysisofreturnsat
variousCAPEstartingpoints.

9
InGrinold,Kroner,andSiegel[2011],theexpectedrealreturnof4.6%(notseparatelyreportedinthatarticle)isthe
expectednominalreturnof7.0%minusexpectedinflationof2.4%.

-9 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

forecasts,somuchthebetter.However,theadjustmentsarenotneededtomotivatemostinvestorsto
holdasubstantial(butnotaboveaverage)equityposition.

Meanwhile,dontexpectCAPEtoreverttoitslongtermaverage.Itismorelikelytofluctuatearoundits
19902014average.

Pricetoanything?

Perhapsthequestforasinglemetricthatgaugesthecheapnessorexpensivenessofthestockmarketis
misguided.Wedbebetteroffusingavarietyofmetrics,includingCAPEforreportedearnings,CAPE
adjustedasSiegelwouldprefer,thetraditionalP/E,pricetobook,pricetosales,pricetodividendsand
capitalizationtoGDP.

TheanonymousPhilosophicalEconomicsbloggerfindsthatthetightestfitbetweenforecastandrealized
10yearstockreturnsisachievedwiththequirkyequitytocapitalizationratio,thevalueofcorporate
equitiesdividedbythevalueofequitiesplusdebt. 10 Thisratiodoesntevenhaveameasureoffundamental
valueinit.Howcanitpossiblywork?

Theansweristhattheamountofdebtacompanycanissue,orchoosestoissue,scalesthepricesothat
pricescanbecomparedacrosscompaniesandacrosstime.Thisscalingeffectisnodifferentthanthe
scalingeffectofdividingpricebyearnings.Infact,allofthemetricslistedabovearescaledprices.I
encouragereaderstouseallthesemetricsandtoseekoutothermetricsnotyetdiscovered.

Conclusion

Myforecastsaysthatthemarketisclosetobeingfairlyvalued,withtheexpectedreturnroughlyequalto
themarketrequiredrateofreturnevenataCAPEof25.AmIsayingthatthistimeitsdifferent?Yes
whileunderlyingprinciplesoffinanceandvaluationarealwaysthesame,thefactsandcircumstancesare
differentineachperiod.Thedatasupportanexpectedrealreturnof4%,whichmakesequitiesworth
holding.

ToreversethefamiliarMarkTwainquote,historyrhymes,butitdoesntrepeatitself.Everytimeis
different.

10

TheSingleGreatestPredictorofFutureStockMarketReturns,December20,2013.Ihaventcheckedthedataor
math,buttheworkseemsright.Ihaveencounteredtheequitytocapitalizationratio(ordebttocapitalization,which
isoneminusequitytocapitalization)inothercontexts,anditscrosssectionallypredictiveofstockreturns(thatit,it
helpstodeterminewhichstockswillbeatthemarket).Itsnotsurprisingthattheratioisalsousefulforpredictingthe
waythattheoverallreturnonthemarketvariesovertime.

- 10 Copyright 2014, Advisor Perspectives, Inc. All rights reserved.

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