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CAPE is not fatally flawed, but I do think that using it across eras with different tax regimes is difficult. CAPEs should be higher after the Tax Cuts and Jobs Act of 2017, for example, as it lowered the tax rate on C corp earnings.
Not much to add other than what is in the article. The impact of buybacks being favoured over dividends is not factored into CAPE multiples, for reasons I discuss in my article. On taxes, ppl would argue pre-tax margins adjust over time to maintain constant ROICs.
That doesn’t make sense. That view relies on math errors in the article. Separately, if pretax margins improve to maintain constant ROICs then I’m right that it increases CAPE because price remains constant while earnings drop.
And most importantly, all backward looking multiple averages assume that the cost of capital is the same over time, when it is not. The cost of capital can increase and decrease. The cost of capital today is substantially less than it was historically.
Another problem is that the composition of the index changes over time, & you can have qualitatively very different companies in index. Apple, Visa, Google, Microsoft, etc, are high quality GLOBAL structural growth business. CAPE assumes all EPS variance is cyclical.
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