The Shiller P/E ratio, a trusted stock-market gauge, just hit its highest level since the dot-com bubble

• The Shiller P/E ratio passed a mark on Monday it last hit during the dot-com bubble.

• The stock-market indicator peaked before the S&P 500 crashed 49% in the early 2000s.

• AJ Bell’s Russ Mould said stocks are pricey, but “you don’t know when trouble is going to strike!”

A trusted market gauge has surged to its highest levels since the dot-com bubble, signaling stocks are the most expensive in 25 years.

The Shiller P/E ratio, also known as the cyclically adjusted price-to-earnings (CAPE) ratio, compares the current value of a stock index like the S&P 500 to its average, inflation-adjusted earnings over the last 10 years.

The S&P’s Shiller P/E ratio crossed 40 on Monday for the first time since 2000, when it reached a record 44. That spike preceded a 49% crash for the benchmark stock index between March 2000 and October 2002 as the internet boom collapsed.

“The US equity market looks expensive relative to its history, pretty much any way you slice it,” Russ Mould, AJ Bell’s investment director, told Business Insider by email.

He added that the Shiller P/E and several other valuation measures are “all in the top 10% of their historic ranges.”

Mould said that “valuation does not guarantee an imminent accident,” but investors might want to take precautions, in part because US stock returns have been “modest to disappointing” when they’ve traded at “similar Shiller P/E multiples to those in evidence now.”

He added, “The tricky bit is 10 years is a long time and you don’t know when trouble is going to strike!”

The Shiller P/E ratio was developed by Nobel Prize-winning economist Robert Shiller, who predicted the dot-com bubble would burst in “Irrational Exuberance,” published just as the market peaked in March 2000.

He correctly warned the housing boom could collapse in the book’s second edition, published in 2005.

Investors use the traditional P/E ratio to value a company’s stock based on its earnings multiple, or how many times higher its price is than its earnings per share, or EPS, in a year. They calculate it by dividing a stock price by an annual EPS figure, either historical or projected.

Similarly, the Shiller P/E ratio takes a stock index’s point value and divides it by the combined EPS of its constituent companies over the last 10 years, adjusted for inflation and divided by 10 to get a real, average figure.

So if the S&P 500 is at 6,700 points, and its average, inflation-adjusted EPS over the last 10 years is $167, dividing one by the other yields a multiple of 40.

The ratio can smooth out the effects of business cycles on profits by factoring in a decade’s worth of earnings, providing a longer-term perspective on market valuation than the conventional P/E ratio.

The Shiller P/E ratio doesn’t indicate an imminent crash, as markets can remain overvalued or undervalued for years.

It also doesn’t account for interest rates, index composition, economic shifts, and corporate profitability, which can vary between time periods and influence valuations.

The S&P 500 has doubled in five years to trade at record highs, led by AI stocks such as Nvidia, which has soared almost 14-fold to become the world’s most valuable public company with a $4.3 trillion market capitalization.

Several commentators have flagged that stocks are pricey. Federal Reserve Chair Jerome Powell said in a Tuesday speech that “equity prices are fairly highly valued.”

Erik Gordon, a professor at the University of Michigan’s Ross School of Business, told Business Insider in August that the huge market values and vast shareholder bases of AI companies like Microsoft and Meta meant “more investors will suffer than suffered in the dot-com crash, and their suffering will be more painful.”

But “Shark Tank” investor Kevin O’Leary and tech investor Ross Gerber dismissed the comparison between the AI boom and the dot-com bubble in separate interviews with Business Insider.

O’Leary said in August that the AI boom isn’t like the dot-com bubble because “you actually can see the productivity and measure it on a dollar-by-dollar basis.”

Gerber said that valuations are justified because AI companies promise tremendous growth and their profitability is “just insane.”

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