Decomposing The Price-Earnings Ratio And Its Application

The price-earnings ratio (P/E) is widely used measure of the expected performance of companies, it is widely used for investors to calculate the years to recover the cost of capital. The price-earnings ratio is generally calculated as price divided by earnings; the price-earnings ratio is an important indicator of valuations and corporate profitability. On the other hand, price-earnings ratio also reflects the company's future growth potential, for a considerable growth potential of the listed company, the market will allow the stocks have higher price-earnings ratio. For investors, analyzing stock price-earnings ratio can discovery the value of shares and higher investment income. However, with an estimate of value of stocks price-earnings ratio there are also many problems. The main reason of price-earnings ratio has been widely used is that it is relatively simple, easy, but the traditional price-earnings ratio method is quite simple. The estimate value of shares will ignore many factors influencing price-earnings ratio. For a specific stock price-earnings ratio there are many factors influencing price-earnings ratio, for example:time, size of the company, the company's industry and the growth rate of EPS, I use Anderson and Brooks (2006) the way of decomposing the price-earning ratio, and according to 1996-2009 Shanghai & Shenzhen stock market listed company's data, I study these factors to correct the price-earnings ratio model. Using a linear regression model I will share the benefits of various factors influencing the extent to quantify, and then use the weighted average influence on price-earnings ratio to format a model of choosing stock, we use this model to divided all stocks into 10 investment portfolios and the results showed that the value type of investment portfolio return significantly higher than the glamour type, the value of decomposition price-earnings ratio model return is higher than traditional price-earnings ratio model, this indicate that the decomposing price-earnings ratio model is valid. We used the risk factors to test the decomposing price-earnings ratio and found using decomposing the price-earnings ratio model of gaining a higher income investment portfolio have fairly high rate of its Sharpe Ratio, decomposing price-earnings ratio model have excess earnings did not take on more risk and the risk factor decomposing price-earnings ratio model is still valid, we can use this model to gain stabile excess return, not need to undertake additional risks.This article is divided into four parts. In the first chapter, I expounded price-earnings ratio into the study of foreign studies, and the study method; In the second chapter I focuses on the sample data, select and comprehensive consideration to price-earnings ratio influence, the existing foreign literature in classifying, summarizing, taking into account the data can be obtained to quantify the nature and were five of the factors influencing price-earnings ratio as research variable; In the third chapter, the factors influencing price-earnings ratio are selected as the agency variable to format the regression model and obtain the results of analysis. And compare the decomposing the price-earnings ratio model to the traditional price-earnings ratio model, finally we using the Sharpe ratio and the long term investment portfolio to test the effectiveness of the model. In conclusion, we summarize the important views of this article, and the specific definition of subsequent research direction.