The Long-Term Price-Earnings Ratio

31 Pages Posted: 8 Jun 2005

See all articles by Keith P. Anderson

Keith P. Anderson

The York Management School

Chris Brooks

University of Bristol - School of Economics, Finance and Management

Multiple version iconThere are 2 versions of this paper

Date Written: May 2005

Abstract

The price-earnings effect has been thoroughly documented and widely studied around the world. However, in existing research it has almost exclusively been calculated on the basis of the previous year's earnings. We show that the power of the effect has until now been seriously underestimated, due to taking too short-term a view of earnings. We look at all UK companies since 1975, and using the traditional P/E ratio we find the difference in average annual returns between the value and glamour deciles to be 6%, similar to other authors' findings. We are able to almost double the value premium by calculating P/E ratios using earnings averaged over the last eight years. Averaging, however, implies equal weights for each past year. We further enhance the premium by optimising the weights of the past years of earnings in constructing the P/E ratio.

Keywords: price-earning ratios, value investing, arbitrage strategy, UK stock market, value premium

JEL Classification: G11, G12, G14

Suggested Citation

Anderson, Keith P. and Brooks, Chris, The Long-Term Price-Earnings Ratio (May 2005). Available at SSRN: https://ssrn.com/abstract=739664 or http://dx.doi.org/10.2139/ssrn.739664

Keith P. Anderson

The York Management School ( email )

York YO10 5DD
United Kingdom

Chris Brooks (Contact Author)

University of Bristol - School of Economics, Finance and Management ( email )

School of Accounting and Finance
15-19 Tyndalls Park Road
Bristol, BS8 1PQ
United Kingdom

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