Forward Price-Earnings Ratio

Abstract

This study analyzes the impact of earnings forecasts in the context of asset management. Earnings forecasts are derived from a cross-sectional earnings forecast model and consensus analyst forecasts. These forecasts form the basis of forward price-earnings ratios, which are implemented in various portfolio strategies to benefit from the PE effect. The out-of-sample earnings forecasts suggest that analysts tend to be more accurate, but also more optimistic. Building on this advantage, the forward price-earnings ratio, the classic price-earnings ratio, and cyclically adjusted price-earnings ratios compete in a portfolio test. After accounting for the necessary transaction costs, the results show that the forward price-earnings ratio based on model forecasts is able to generate significantly higher total returns than all other ratios across different strategies.

Keywords: Earnings Forecasts, Asset Management, Cross-Sectional Earnings Models

JEL Classification: G11, G12, G17, G30, M40, M41