Is China’s P/E Ratio Too Low? Examining the Role of Earnings Volatility
Tony S. Wirjanto
University of Waterloo, School of Accounting & Finance and Department of Statistics & Actuarial Science
Alan Guoming Huang
University of Waterloo
July 25, 2010
Pacific-Basin Finance Journal, Forthcoming
We find that China’s P/E ratio is comparable to that of the U.S. S&P 1500 index, a broad based index covering large, middle, and small capitalization firms. We provide an explanation as to why China’s seemingly low P/E ratio is not surprising in light of the economic growth that it has experienced. Specifically, we show that (i) the P/E ratio is negatively associated with earnings volatility in both the Chinese and U.S. stock markets with an economically significant magnitude; and (ii) historical earnings volatility is considerably higher in China than in the U.S. Higher earnings volatility in China offsets higher growth prospect in setting the P/E ratio, making its P/E ratio much closer to what is observed empirically than otherwise implied by its growth rate.
Number of Pages in PDF File: 42
Keywords: P/E ratio, China, U.S., earnings volatility
JEL Classification: G15, G13, G32
Date posted: July 1, 2010 ; Last revised: August 1, 2011
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