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CAPE-H Explained: What the Proposed Accounting Adjustments Change

Steven Levine, Founder of TickerPosts and OpenClassActions.com2 min read
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Illustrative photo by Tima Miroshnichenko on Pexels

CAPE-H stands for “Historically-comparable CAPE.” It is the adjusted valuation ratio proposed in Dino Palazzo's working paper, The CAPE That Cried Wolf. The idea is to compare long-run earnings using a more consistent accounting basis as the economy and reporting practices change.

The two adjustments

The paper makes two changes to reported earnings before calculating a CAPE-style average:

  • Add back R&D expenditures. US GAAP generally expenses R&D as it is incurred under FASB Statement No. 2. The paper adds that expense back to reduce the understatement it believes arises as R&D-intensive activity grows.
  • Exclude special items. The paper removes designated unusual charges, including categories such as restructuring and impairments, to limit their effect on the long-run earnings series.

It then uses the adjusted earnings in a cyclically adjusted valuation ratio. The author describes the exercise as a measurement-consistency correction, not a complete estimate of “economic earnings.”

What CAPE-H is not

CAPE-H does not create a separate R&D asset for each company, assign that asset a useful life, or amortize the spending over a modeled period. Those steps would require additional assumptions about which research creates durable value and how quickly that value fades.

It also does not remove every economic weakness from a long historical series. Index membership changes, payout practices, tax rules, corporate structure and market discount rates can still affect the comparison. Excluding a charge from a measure does not make the underlying cash cost disappear.

What the paper reports

In the supplied manuscript, Palazzo reports that CAPE-H avoids the persistent upward shift found in traditional CAPE after the early 1990s and restores positive out-of-sample forecasts for cumulative price appreciation over some multi-year horizons. The paper's decomposition attributes the result to the price-change component rather than reliable prediction of dividend growth.

These findings depend on the author's data, definitions and forecasting procedure. They are evidence for further study, not proof that CAPE-H will outperform every alternative measure or produce useful results in all future samples. The paper itself describes a working-paper analysis; readers should consult the linked record for the available version and methodological details.

For the underlying accounting choices, read how R&D expensing and special items affect CAPE. For a broader discussion of what a valuation ratio can and cannot say, see CAPE, Accounting and Long-Term Stock Returns: A Plain-English Pillar Guide.

Sources