Price Earning Ratio, Efficiency and Portfolio Performance

Abstract

Price earning ratios are widely applied by investors to make investment decisions and to determine the future behaviour of stock price. We measure the performance of a set of portfolios which are based on P/E of stocks. The study examines the monthly price-earning ratios of BSE 100 companies, for the period June 1996–May 2005, and three non-overlapping sub-periods (June 1996–December 1999, January 2000–December 2002, and January 2003–May 2005). It found no consistency between the portfolios’ expected return and their corresponding P/E ratios. It is observed that the stock market failed to reflect instantaneous response pertaining to earnings information. However, during the pool and sub-periods’, the relationship between portfolio expected return and market risk is found to be positive and significant. These findings question the efficient market hypothesis but hold the application of the capital asset pricing model in the Indian stock market.

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This chapter contains portions drawn from the author’s previous publication (Dhankar & Kumar, 2007), co-authored with Rakesh Kumar, Assistant Professor, Department of Business Studies, Deen Dayal Upadhyaya College (University of Delhi ), New Delhi, originally published in The ICFAI Journal of Applied Finance, and re-used here with permission.