Sticking to a tried-and-tested investment philosophy doesn’t mean standing still. In our search for continual improvement, we outline the key reasons why Brickwood has adopted the cyclically adjusted price-to-earnings yield (‘CAPE Yield’) as our primary valuation measure.
At Brickwood, we have the rare opportunity to build an asset management firm from scratch. Starting with a blank sheet of paper, we could design an investment process and culture without compromise.
Yet, that blank sheet also came with responsibility: every process needed to be built from scratch. We have taken this opportunity to challenge every assumption, every input, and every aspect of our investment process, without exception.
For value investors, few metrics are more sacred than the price-to-earnings (‘P/E’) ratio. Alongside dividend yield and price-to-book, it forms the holy trinity of valuation metrics—the very foundation of how most investors think about value. But is the P/E still the gold standard? Or is it time to question its prominence?
P/E works – but can be refined
Before we go any further, let’s be clear: the P/E ratio works. There’s plenty of academic evidence to support that. The P/E ratio as a valuation metric has delivered good results in the past, and we firmly believe it will continue to do so. At their core, valuation strategies exploit the recurring behavioural mistakes investors make—swinging between fear and greed, pushing share prices beyond what the fundamentals justify. No matter how markets evolve—economically, politically, or technologically—those behavioural patterns are unlikely to change. But we also believe the simple P/E ratio can be refined in three important ways.
1. Earnings cyclicality matters
Most companies experience some level of cyclicality: their earnings rise and fall with the economic cycle, making it essential to consider not just the multiple but also where profits sit within the cycle. Yet, we often hear statements like, “This stock is on a P/E of 10x, so it’s a bargain.” Context matters. A 10x multiple might be a once-in-a-generation opportunity if earnings are at their lowest point, but dangerously expensive if they’re at their cyclical peak.
To reflect this, at Brickwood our first adjustment to the standard P/E is to smooth out earnings fluctuations by averaging profits over an economic cycle. This method, known as the Graham and Dodd P/E—named after legendary value investors Ben Graham and David Dodd—provides a more stable and meaningful valuation benchmark.
The Graham and Dodd P/E is an effective tool within a single market and moment in time. Each of Brickwood’s founders used it for years in UK portfolios, delivering attractive returns.
But what if you’re comparing investment opportunities across regions? Or measuring today’s market against past cycles? In those cases, another adjustment is necessary.
2. Adjusting for inflation
For much of the past decade, inflation barely registered across developed markets, causing many to forget about its importance. But with inflation now firmly back in the picture, its impact is impossible to ignore, and valuations should therefore reflect not just average earnings but their real value when expressed in today’s money.
Adjusting an entire market for inflation is relatively straightforward, requiring just ten data points for aggregate profits and ten inflation numbers. But adjusting for inflation at the company level, for every single constituent of a benchmark, demands tens of thousands of data points. This complexity is why it’s rarely attempted.
At Brickwood, we made sure from day one that we had the data, models, and systems to adjust not only for the economic cycle, but to systematically inflation-adjust every company’s financial history. This allows for true comparability—between companies and across markets, between today’s opportunities and those of the past.
3. From valuation to return potential
But comparability alone isn’t enough. Even when using cyclically and inflation-adjusted earnings, the P/E ratio has another shortcoming: it is silent on the return implied by a given valuation. Starting valuation drives future returns—that’s the cornerstone of value investing. The challenge is that its effect is counterintuitive: a lower starting valuation tends to lead to higher returns, but the P/E gives no insight as to how significant those returns could be.
Bond investors side-step this issue by focusing on yield, rather than price multiples. Instead of saying a bond trades at 20x its coupon, they focus on a 5% yield. Instead of 10x, they say 10%. It’s a simple inverse, but a clearer, more intuitive way of expressing return potential.
Value managers have spent decades talking about P/E ratios of 10x versus a market at 20x—a metric that does little to highlight return potential. So why not apply the same logic to equities and express the P/E as a cyclically adjusted price-to-earnings yield (‘CAPE Yield’) instead?
Putting theory into practice
Expressing the P/E as a yield is a more intuitive way to describe its return potential. But in practice, what is the historic relationship between CAPE Yield and subsequent returns? Does a CAPE Yield of 5% actually translate into an expected 5% return?
We have analysed over 150 years of historic data and we think the answer is ‘yes’. As the chart below shows, the historic relationship is very clear: investing in securities with high CAPE Yields has generated above-average returns over time (1). Not only that, but there has been a clear, linear relationship between CAPE Yield and subsequent returns. For example, the average 10-year return for investors who have invested in equities with a 2-4% CAPE Yield has been between 2% and 4%. The average return for investors who have invested in equities with an 8-10% CAPE Yield has been between 8% and 10%.
We think this data supports a very powerful message: history suggests that long-run returns are likely to be roughly in line with starting CAPE Yields. That’s why Brickwood has adopted CAPE Yield as our primary valuation measure. Our recently launched TM Brickwood UK Value Fund and TM Brickwood Global Value Fund both have CAPE Yields above 12% (2), compared to 6% and 3.5%, respectively, for their benchmarks (3).
There are no guarantees in investing, but framing valuations in terms of CAPE Yield makes the connection between price, risk and return far clearer. Just as importantly, it allows us to have higher-quality, more transparent conversations with clients.
1. Professor Shiller’s Data (available at ShillerData.com) from 1st January 1871 to 31st July 2025.
2. The value of assets can go up and down, past performance is not indicative of future results. Source: Brickwood, 31st August 2025
3. The FTSE All Share Index and the MSCI AC World Index (‘ACWI’) as at 31st August 2025.
- Thought Leadership