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The Extremes of the P/E Effect

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  • Keith Anderson

    (ICMA Centre, University of Reading)

  • Chris Brooks

    (ICMA Centre, University of Reading)

Abstract

The price-earnings effect has been a challenge to the idea of efficient markets for many years. The P/E used has always been the ratio of the current price to the previous year's earnings. However, the P/E is partly determined by outside influences, such as the year in which it was measured, the size of the company, and the sector in which the company operates. Looking at all UK companies since 1975, we determine the power of these influences, and find that the sector influences the P/E in the opposite direction to the others. We use a regression to weight the influences according to their power in predicting returns, reversing the sector influence so that it works for us and not against us. The resulting weighted P/E widens the gap in annual returns between the value and glamour deciles by 8%, and identifies a value decile with average returns of 32%.

Suggested Citation

  • Keith Anderson & Chris Brooks, 2005. "The Extremes of the P/E Effect," ICMA Centre Discussion Papers in Finance icma-dp2005-04, Henley Business School, University of Reading.
    • Handle: RePEc:rdg:icmadp:icma-dp2005-04
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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2005-04.pdf
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    References listed on IDEAS

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    1. Keith Anderson & Chris Brooks, 2005. "Decomposing the P/E Ratio," ICMA Centre Discussion Papers in Finance icma-dp2005-03, Henley Business School, University of Reading.
    2. Keith Anderson & Chris Brooks, 2005. "The Long-Term P/E Radio," ICMA Centre Discussion Papers in Finance icma-dp2005-02, Henley Business School, University of Reading.
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    1. Keith Anderson & Chris Brooks, 2005. "Decomposing the P/E Ratio," ICMA Centre Discussion Papers in Finance icma-dp2005-03, Henley Business School, University of Reading.

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