Molson Hart

I discuss here how the CAPE can be highly misleading in a world with buybacks. https://lt3000.blogspot.com/2017/02/why-cape-multiple-is-fatally-flawed.html?m=1 …

3. The mathematical operation you used to get 19.7x is not equivalent to the mathematical operation used to get 15x. Market Cap(today)/Average(Earnings(1), ..., Earnings(10)) =/= Share Price(today)/Average(EPS(1), ..., EPS(10)) Because the # of shares in each year changes.

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.

No response on this?

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.

There are no math errors in the article. With no variance in operating earnings, buybacks increase EPS. Dividends do not. CAPE uses 7-yr average inflation-adjusted EPS, so CAPE will be higher under buyback scenario. On latter para, no because CAPE uses post-tax EPS.