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Article
Publication date: 5 June 2017

Boonlert Jitmaneeroj

A large number of empirical studies investigate the determinants of price-earnings (P/E) ratio by focusing on fundamental factors. However, there has been an increasing…

Abstract

Purpose

A large number of empirical studies investigate the determinants of price-earnings (P/E) ratio by focusing on fundamental factors. However, there has been an increasing concern that stock valuation is also driven by investor sentiment. This paper aims to extend the existing literature by exploring whether investor sentiment impacts the P/E ratio.

Design/methodology/approach

The paper examines the determinants of P/E ratio by applying latent variable models with investor sentiment as a latent variable and several fundamental factors as control variables. Investor sentiment is proxied by trading volume, advance-decline ratio and price volatility.

Findings

Using annual data of the US industries over the period of 1998-2014, the current paper produces new empirical evidence that investor sentiment significantly affects the P/E ratio. This result is robust to the inclusion of several control variables that have been documented to explain the P/E ratio.

Practical implications

The findings have important implications for investors, as downplaying sentiment can lead to significant errors in making equity investment choices based on the P/E ratio.

Originality/value

The analytical framework of the current paper is differentiated from the conventional analysis in which the P/E ratio is regressed against control variables and proxies for sentiment, thus falling into the trap of implicitly presupposing that proxies are perfect measures of investor sentiment. As all proxies may have measurement errors to the true but unobservable investor sentiment, the current paper uses latent variable models to shed new light on the influence of investor sentiment on the P/E ratio.

Details

Studies in Economics and Finance, vol. 34 no. 2
Type: Research Article
ISSN: 1086-7376

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Article
Publication date: 13 February 2017

Boonlert Jitmaneeroj

This paper aims to examine the conditional and nonlinear relationship between price-earnings (P/E) ratio and payout ratio. A common finding of previous studies using…

Abstract

Purpose

This paper aims to examine the conditional and nonlinear relationship between price-earnings (P/E) ratio and payout ratio. A common finding of previous studies using linear regression model is that the P/E ratio is positively related to the dividend payout ratio. However, none of them investigates the condition under which the positive relationship holds.

Design/methodology/approach

This paper uses the fixed effects model to investigate the conditional and nonlinear relationship between P/E ratio and payout ratio. With the inclusion of fundamental factors and investor sentiment, this model allows for nonlinear relationship to be conditioned on the return on equity and the required rate of return.

Findings

Based on the annual data of industries in the USA over the period of 1998-2014, this paper produces new evidence indicating that when the return on equity is greater (less) than the required rate of return, the P/E ratio and dividend payout ratio exhibit a negative (positive) relationship and positive (negative) convexity.

Practical implications

Due to the curvature relationship between P/E ratio and payout ratio, the corporate managers and stock investors should pay more attention to the reduction in payout ratio than the rising payout ratio and the companies with low payout ratios than the companies with high payout ratios.

Originality/value

No previous study has tackled the issue of conditional and nonlinear relationship between P/E ratio and payout ratio. This paper attempts to fill the gap by allowing for nonlinear relationship conditional on the relative values of the return on equity and the required rate of return.

Details

Review of Accounting and Finance, vol. 16 no. 1
Type: Research Article
ISSN: 1475-7702

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Article
Publication date: 1 September 2005

Javier Estrada

The purpose of this study is to compare the performance of a low‐P/E strategy relative to that of two alternative value strategies, one based on the PEG ratio and another…

Abstract

Purpose

The purpose of this study is to compare the performance of a low‐P/E strategy relative to that of two alternative value strategies, one based on the PEG ratio and another on the PERG ratio (a magnitude introduced in this article).

Design/methodology/approach

The data used consists of a sample of 100 US companies between January 1975 and September 2002. Portfolios are formed on the basis of different valuation ratios, and their performance is compared in order to determine the best‐performing strategy.

Findings

Portfolios sorted by PERG ratios outperform, on a risk‐adjusted basis, those sorted by both P/E ratios and PEG ratios. This outperformance occurs regardless of whether portfolios are not rebalanced, rebalanced every ten years, or rebalanced every five years.

Research limitations/implications

The sample of stocks is not large. The results could be validated by using a larger sample of US stocks and a longer time period, as well as by using a sample of stocks from several international markets.

Practical implications

The PERG ratio proposed in this article improves on the PEG ratio, adjusting the latter by risk. That, plus the fact that PERG‐based strategies outperform on a risk‐adjusted basis strategies based on both P/Es and PEGs, should make it an attractive tool to add to the arsenal of valuation tools used by analysts.

Originality/value

A new valuation tool is proposed, called the PERG ratio, that adjusts P/E ratios by both growth and risk (or, similarly, PEG ratios by risk).

Details

International Journal of Managerial Finance, vol. 1 no. 3
Type: Research Article
ISSN: 1743-9132

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Article
Publication date: 1 April 2002

Ben Amoako‐Adu and Brian Smith

Criticizes previous research on price/earnings ratios (PER) for neglecting their historical links with interest rates and analyses the causal links between interest ratres…

Abstract

Criticizes previous research on price/earnings ratios (PER) for neglecting their historical links with interest rates and analyses the causal links between interest ratres and the PERs of the Toronto Stock Exchange 300 Index (TSE300) and of seven major Canadian industries 1965‐1997. Explains the methodology and identifies three “distinct PER regimes”: 1965‐1974 (average PER 17.17), 1975‐1982 (average PER 8.92) and 1983‐1997 (average PER 17.2 with a higher standard deviation). Looks at the economic conditions for each period and suggests that current PERs “may not be too high”. Finds a negative correlation between PERs and treasury bill rates, differing between industries; and that the bill rate explains 95 per cent of PER variation for the TSE300, although it is not significant for the gold and silver industry. Adds that divided payout ratios and lower investor risk aversion are positively related to PERs, but that growth rate has a more variable influence. Summarizes the findings and their implications for PER forecasters.

Details

Managerial Finance, vol. 28 no. 4
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 13 July 2015

Donna M. Dudney, Benjamas Jirasakuldech, Thomas Zorn and Riza Emekter

Variations in price/earnings (P/E) ratios are explained in a rational expectations framework by a number of fundamental factors, such as differences in growth expectations…

Abstract

Purpose

Variations in price/earnings (P/E) ratios are explained in a rational expectations framework by a number of fundamental factors, such as differences in growth expectations and risk. The purpose of this paper is to use a regression model and data from four sample periods (1996, 2000, 2001, and 2008) to separate the earnings/price (E/P) ratio into two parts – the portion of E/P that is related to fundamental determinants and a residual portion that cannot be explained by fundamentals. The authors use the residual portion as an indicator of over or undervaluation; a large negative residual is consistent with overvaluation while a large positive residual implies undervaluation. The authors find that stocks with larger negative residuals are associated with lower subsequent returns and reward-to-risk ratio, while stocks with larger positive residuals are associated with higher subsequent returns and reward-to-risk ratio. This pattern persists for both one and two-year holding periods.

Design/methodology/approach

This study uses a regression methodology to decompose E/P into two parts – the portion of E/P than is related to fundamental determinants and a residual portion that cannot be explained by fundamentals. Focussing on the second portion allows us to isolate a potential indicator of stock over or undervaluation. Using a sample of stocks from four time periods (1996, 2000, 2001, and 2008, the authors calculate the residuals from a regression model of the fundamental determinants of cross-sectional variation in E/P. These residuals are then ranked and used to divide the stock sample into deciles, with the first decile containing the stocks with the highest negative residuals (indicating overvaluation) and the tenth decile containing stocks with the highest positive residuals (indicating undervaluation). Total returns for subsequent one and two-year holding periods are then calculated for each decile portfolio.

Findings

The authors find that high positive residual stocks substantially outperform high negative residual stocks. This is true even after risk adjustments to the portfolio returns. The residual E/P appears to accurately predict relative stock performance with a relatively high degree of accuracy.

Research limitations/implications

The findings of this paper provide some important implications for practitioners and investors, particularly for the stock selection, fund allocations, and portfolio strategies. Practitioners can still rely on a valuation measure such as E/P as a useful tool for making successful investment decisions and enhance portfolio performance. Investors can earn abnormal returns by allocating more weights on stocks with high E/P multiples. Portfolios of high E/P multiples or undervalued stocks are found to enjoy higher risk-adjusted returns after controlling for the fundamental factors. The most beneficial performance holding period return will be for a relatively short period of time ranging from one to two years. Relying on the E/P valuation ratios for a long-term investment may add little value.

Practical implications

Practitioners and academics have long relied on the P/E ratio as an indicator of relative overvaluation. An increase in the absolute value of P/E, however, does not always indicate overvaluation. Instead, a high P/E ratio can simply reflect changes in the fundamental factors that affect P/E. The authors find that stocks with larger negative residuals are associated with lower subsequent returns and coefficients of variation, while stocks with larger positive residuals are associated with higher subsequent returns and coefficients of variation. This pattern persists for both one and two-year holding periods.

Originality/value

The P/E ratio is widely used, particularly by practitioners, as a measure of relative stock valuation. The ratio has been used in both cross-sectional and time series comparisons as a metric for determining whether stocks are under or overvalued. An increase in the absolute value of P/E, however, does not always indicate overvaluation. Instead, a high P/E ratio can simply reflect changes in the fundamental factors that affect P/E. If interest rates are relatively low, for example, the time series P/E should be correspondingly higher. Similarly, if the risk of a stock is low, that stock’s P/E ratio should be higher than the P/E ratios of less risky stocks. The authors examine the cross-sectional behavior of the P/E (the authors actually use the E/P ratio for reasons explained below) after controlling for factors that are likely to fundamentally affect this ratio. These factors include the dividend payout ratio, risk measures, growth measures, and factors such as size and book to market that have been identified by Fama and French (1993) and others as important in explaining the cross-sectional variation in common stock returns. To control for changes in these primary determinants of E/P, the authors use a simple regression model. The residuals from this model represent the unexplained cross-sectional variation in E/P. The authors argue that this unexplained variation is a more reliable indicator than the raw E/P ratio of the relative under or overvaluation of stocks.

Details

Managerial Finance, vol. 41 no. 7
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 30 March 2021

Yuxin Wang and Guanying Wang

The purpose of this paper is to explore how the price limit policy implemented in 2014 affects initial public offering (IPO) underpricing and long-term performance in China.

Abstract

Purpose

The purpose of this paper is to explore how the price limit policy implemented in 2014 affects initial public offering (IPO) underpricing and long-term performance in China.

Design/methodology/approach

The data are the IPOs from Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SZSE) between 2004 and 2018. The data are firstly divided into the IPOs before the price limit policy and the IPOs after the price limit policy according to the time of issuance. Then the two groups are divided into 4 subsamples according to the market blocks and the P/E ratio. The authors use multiple regression models to explore the effect of price limit policy in each subsample.

Findings

The first-day price limit system for IPOs is similar to the upward fuse mechanism, the purpose of which is to suppress IPO underpricing. However, this study finds that the policy does not suppress IPO underpricing, but increases the underpricing rate in all subsamples. Besides, the long-term performance in each subsample is different from each other. Main Board stocks’ long-term performance is worse after the policy. The policy makes Small and Medium Enterprise Board (SME Board) and Growth Enterprise Market Board (GEM Board) stocks with high P/E ratios perform better in the long term. For SME Board and GEM Board stocks with low P/E ratios, the policy makes no significant effect.

Practical implications

Good policy intentions may sometimes lead to counterproductive effects. However, since the long-term performance of each subsample is different, it is difficult to judge whether the policy should continue to be implemented or cancelled. Implementing different policies for different subsamples may be a better way to solve this problem.

Originality/value

This paper contributes to the study of IPO underpricing and long-term performance from the perspective of price limit policy.

Details

Managerial Finance, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 0307-4358

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Book part
Publication date: 21 July 2004

Hemantha S.B. Herath and John S. Jahera

The flexibility of managers to respond to risk and uncertainty inherent in business decisions is clearly of value. This value has historically been recognized in an ad hoc…

Abstract

The flexibility of managers to respond to risk and uncertainty inherent in business decisions is clearly of value. This value has historically been recognized in an ad hoc manner in the absence of a methodology for more rigorous assessment of value. The application of real option methodology represents a more objective mechanism that allows managers to hedge against adverse effects and exploit upside potential. Of particular interest to managers in the merger and acquisition (M&A) process is the value of such flexibility related to the particular terms of a transaction. Typically, stock for stock transactions take more time to complete as compared to cash given the time lapse between announcement and completion. Over this period, if stock prices are volatile, stock for stock exchanges may result in adverse selection through the dilution of shareholder wealth of an acquiring firm or a target firm.

The paper develops a real option collar model that may be employed by managers to measure the market price risk involved to their shareholders in offering or accepting stock. We further discuss accounting issues related to this contingency pricing effect. Using an acquisition example from U.S. banking industry we illustrate how the collar arrangement may be used to hedge market price risk through flexibility to renegotiate the deal by exercising managerial options.

Details

Advances in Management Accounting
Type: Book
ISBN: 978-0-76231-118-7

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Book part
Publication date: 20 June 2003

John D Martin and Akin Sayrak

This paper asks whether market fundamentals can explain the run-up and collapse of Enron’s stock price and price-earnings ratio. We use a variant of the discounted cash…

Abstract

This paper asks whether market fundamentals can explain the run-up and collapse of Enron’s stock price and price-earnings ratio. We use a variant of the discounted cash flow model proposed by Miller and Modigliani (1961) to show that the growth rates implied by the stock’s valuation have rarely been achieved in recorded business history. We also provide evidence of earnings management by the company that may have contributed to extravagant investor expectations of earnings growth. Between 1990 and 2000 the firm’s reported earnings met or exceeded analysts’ earnings forecasts 77% of the time. Furthermore, beginning in 1997 Enron used asset sales (often to related parties) to generate as much as 83% of its annual earnings.

Details

Advances in Financial Economics
Type: Book
ISBN: 978-1-84950-214-6

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Article
Publication date: 14 June 2011

Oronzio Manca, Sergio Nardini and Daniele Ricci

The purpose of this paper is to investigate the flow and the heat transfer characteristics of a two‐dimensional rib‐roughned rectangular duct with the two principal walls…

Abstract

Purpose

The purpose of this paper is to investigate the flow and the heat transfer characteristics of a two‐dimensional rib‐roughned rectangular duct with the two principal walls subjected to uniform heat flux. In particular, the main goal is to generate friction and heat transfer data, for different values of p/e with square, rectangular, trapezoidal and triangular shape ribs for Reynolds numbers in the range between 20,000 and 60,000 and different heights and to describe the temperature and fluid‐dynamic fields around the ribs.

Design/methodology/approach

The model is constituted by a two‐dimensional duct. On the duct wall square, rectangular, triangular and trapezoidal ribs are introduced by changing different geometry ratios. Governing equations are solved numerically by means of the finite‐volume method.

Findings

Simulations show that maximum Nusselt numbers are detected in correspondence with dimensionless pitch equal to 12 and 10 for the square, trapezoidal and rectangular ribs, and triangular ones, respectively. Heat transfer rate is at most 2.45 times higher than the smooth duct, when dimensionless height is equal to 0.05, and 1.85 at a dimensionless height equal to 0.02; furthermore, the friction factor is the highest at a pitch ratio of ten for the rectangular, trapezoidal and square ribs while the triangular ones show the maximum values at a dimensionless pitch equal to 8. For Re>40,000 an asymptotic behavior is detected. Best thermal performances are provided by triangular ribs with w/e=2.0 while the rectangular ribs with w/e=2.0 present the lowest friction factor values. Local Nusselt number profiles reveal that the maximum values are detected from three to five times the rib height from the downstream turbulator. Finally, temperature fields and stream function contours are given in order to visualize the temperature distribution and flow pattern in presence of d‐type and k‐type roughness behavior also for triangular ribs.

Originality/value

The paper investigates evaluation of temperature and velocity fields thermal and fluid‐dynamic behaviors (in terms of average and local Nusselt number profiles and friction factors ones) of roughned ducts with different shapes, heights and aspect ratios of ribs in turbulent regime. The thermo‐physical properties of fluid are assumed to be dependent on temperature. The paper is useful to thermal designers.

Details

International Journal of Numerical Methods for Heat & Fluid Flow, vol. 21 no. 5
Type: Research Article
ISSN: 0961-5539

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Article
Publication date: 1 December 1997

Paul Sergius Koku

Investigates the effectiveness of corporate name change signaling in the services industry. Argues that previous studies on the subject are lacking because they failed to…

Abstract

Investigates the effectiveness of corporate name change signaling in the services industry. Argues that previous studies on the subject are lacking because they failed to distinguish between the services and manufacturing sectors. Uses the trend analysis method and examines the movement of price‐earning ratios during a five‐year period before and after the name change. Evaluates the effectiveness of the name change signaling strategy by testing the difference in means of the “before and after” P/E ratios. Finds that firms who announce name change together with other managerial decisions and regularly release news on other firm‐specific activities fared much better than firms which did not release such information.

Details

Journal of Services Marketing, vol. 11 no. 6
Type: Research Article
ISSN: 0887-6045

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