Is China’s P/E Ratio Too Low? Examining the Role of Earnings Volatility

42 Pages Posted: 1 Jul 2010 Last revised: 1 Aug 2011

Tony S. Wirjanto

Department of Statistics & Actuarial Science and School of Accounting & Finance, University of Waterloo,

Alan Guoming Huang

University of Waterloo

Date Written: July 25, 2010

Abstract

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.

Keywords: P/E ratio, China, U.S., earnings volatility

JEL Classification: G15, G13, G32

Suggested Citation

Wirjanto, Tony S. and Huang, Alan Guoming, Is China’s P/E Ratio Too Low? Examining the Role of Earnings Volatility (July 25, 2010). Pacific-Basin Finance Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1632667 or http://dx.doi.org/10.2139/ssrn.1632667

Tony S. Wirjanto

Department of Statistics & Actuarial Science and School of Accounting & Finance, University of Waterloo, ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)

HOME PAGE: http://https://uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

Alan G. Huang (Contact Author)

University of Waterloo ( email )

School of Accounting and Finance
Waterloo, Ontario N2L 3G1
Canada
519-888 4567 ext. 36770 (Phone)

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