Rankings of Published Price-Earnings Ratios and Value Investor Attention

Abstract

Price-earnings (P/E) ratios are the most popular proxy for fundamental value and are widely published using a common methodology. This paper explores whether stocks with high P/E rankings are especially salient to individual investors with attention constraints. Consistent with the role of attention, P/E rankings predict the returns of strategies based on size, liquidity, and short-term reversals as well as increases in trading volume and liquidity. Financial data providers publish P/E ratios for stocks with positive earnings, but do not publish P/E ratios for stocks with negative earnings. P/E rankings predict returns and changes in trading volumes for stocks with positive earnings, but not for stocks with negative earnings. In an event study of all stocks which cross the 0 P/E threshold, the value of a positive P/E ratio is around 2.25%. Stocks which cross into positive P/E territory trade more actively than stocks which cross into negative P/E territory. Overall, a value-weighted extreme decile P/E attention strategy earns average monthly returns of 119 basis points from 1973 to 2015 with an annual Sharpe ratio of 0.94. These strategy returns are robust to fundamental factors and momentum in prices and earnings individually.

Keywords: P/E Ratios, Limited Attention, Investor Behavior, Trading Volume, Liquidity

JEL Classification: G12