 Good day, fellow investors. My name is Sven Karlin and today I'll discuss a financial metric, valuation metric that I like very much when I do investment analysis. That is the Psychical Adjusted Price-Earnings Ratio. You have a normal price earnings ratio that compares the price of a stock and the earnings. The lower is usually the better, depending on the situation with stock. What the Psychical Adjusted Price-Earnings Ratio does, it checks the price of the stock, but it takes 10 year average earnings for the price earnings ratio. They say Professor Robert Schiller invented the ratio, but if you look at Graham's book Security Analysis and the Intelligent Investor, you can see that Graham already uses 5-10 year average earnings. So it's not an invention, he just publicized, made an academic article and got the Nobel Prize, smart thing to do. So what is the Psychical Adjusted Price-Earnings Ratio? As I said, it's just based on 10 year earnings. Price-earnings ratio, but you take 10 years, take the average and you get the Psychical Adjusted Price-Earnings Ratio. Why is the 10 year span important? The 10 year span important is because economics and sectors and everything works in cycles. And that's normal human nature. You cannot avoid it. We will always want a bit more and try to push everything as far as it goes, take more credit, leave to the limit, and then there is always a turning point where we cannot spend more, we cannot take more credit and there is an inflection. At that point all the bad companies get erased and then we start a new cycle that goes even higher than the one before. It has happened during the last 5,000 years, so nothing to worry about there. It's normal, however investors can take extreme advantage of such Psychicalities. And one ratio that shows how to take advantage is the K-P Ratio. Here I compared the K-P Ratio from the 1980s and the Price-Earnings Ratio. The K-P Ratio is blue and the Price-Earnings Ratio is orange. You can see how the K-P Ratio is much much less volatile than the Price-Earnings Ratio. Because Psychical effects like short-term booms in economies or very very terrible happenings like the 2009 are slowly erased and the K-P really shows the real value behind the stock. So if you are interested in real values the K-P Ratio is the one to look at. For example if we look at 2002 we can see how the K-P Ratio in this green circle was much lower signaling a buying opportunity. 2009 also very low K-P Ratio signals a buying opportunity. High K-P Ratios signal an overvalued market and the Price-Earnings Ratio goes all over the place so you really cannot use it as a significant investing factor. Now you won't hear much talk about the K-P Ratio because it brings bad news. You can see here that the current K-P Ratio is at historical highs. It has been higher in the 2000s.com bubble. We are close to Black Tuesday 1929 and we all know what happened after 1929 and 2007. So if we look at the K-P Ratio there is trouble ahead at least for the SAP 500. What's also very significant in is to look at average returns in relation to the K-P Ratio. And you can see in this chart this is for all countries since 1881. So you can see in this chart how the lower the K-P Ratio the higher are 15 year returns. So when the K-P Ratio is below 10 global returns on stocks have always been higher than 5% and even went to 20% in the next 15 years. Thus we are talking about yearly returns about 20% which are great. When the K-P Ratio was higher than 30 or higher than 25 the red dots here and the green dots are from Sweden and Denmark. So that's a different story and the blue dots are from all countries and the green dots are from the SAP 500. So never in history have returns been higher than 5% per year when the K-P Ratio was higher than 20. Now we are at 30. And also what's significant is that when the K-P Ratio is higher than 10-12 long-term returns are usually between 5% and 0 and then they turn negative when the K-P Ratio is above 20. So if you are an investor that looks at the big picture a longer term picture you might be very very interesting in knowing and using the K-P Ratio just as a measure of risk. I like to use it to check countries. There are always some trouble in emerging market countries and then if I look at the K-P Ratio I look at the fundamentals long-term fundamentals and the K-P tells me okay this is a crisis it will get better. Sectors is good to take the K-P Ratio. Sectors are also very volatile car mining reads now so very good to use the K-P. And K-P is also good growth stocks not so much but for individual companies that are individually long-term stable companies then you can see what happens. Perhaps there will be some impairments and then one year price earnings ratio are low or the stock is low but the Cape shows you that it's a good investment or you can see if it's overvalued the Cape shows you it's not so such a good investment and you can sell. Now there is also an ETF that uses K-P Ratio and rebalances across sectors and it has outperformed very significantly the equally weighted sector strategy and the SAP 500 so the Cape really really works. And what's also very important for us investors is to see how sectors are irrationally priced over time. If we take a look at the SAP 500 divided by sectors we can see how in the 1990s energy stocks were very hot materials were growing to 2012 industrials were hot around 1997 consumer discretionary was hot 2010-12 consumer staples is very cheap now healthcare was hot and getting hotter again and now is extremely hot financials are very volatile utilities are currently very trendy technology has been very interesting in the 2000s and now then it was cheap in 2012 when this study was made and now it's again very expensive. So sectors the Cape helps and you can always go global. This picture we can see Cape ratios across the world Russia the cheapest China very cheap Brazil cheap Italy's cheap energy stocks we will discuss that in another video so US the Netherlands Europe parts of Europe very very expensive according to the Cape ratio. So I hope I have added value we'll be using the Cape in the next videos that we'll be making about emerging markets emerging market stocks countries sectors it's a very very good metric to show the long-term picture. Thank you for watching please leave your questions comments likes below subscribe for more content we have reached 100 subscribers I'm very grateful for that and I didn't expect it so I'm very very happy thank you and I'll see you in the next video