Basing Portfolio Investment Decisions on P/E Premium and Expected Returns in Pakistan’s Equity Market
Keywords:
Asset Pricing, P/E Premium, Market premium, KSE, CAPM, APTAbstract
This paper examines the relationship between P/E ratios and investment performance of equity securities in Karachi Stock Exchange (KSE) which is the national stock exchange of Pakistan having more than 600 listed companies, comprising 34 sectors of the economy. Stock price data for June 2012-July 2017 has been used to test the intended relationships. Securities for each year were sorted on the basis of price to earnings (P/E) ratio and two portfolios were constructed, each comprising 30 percent securities on the basis of highest and lowest P/E ratios. The difference between returns of two portfolios provided P/E premium. Further, to test the relationship between P/E ratio premium and equity market return, the portfolio returns were regressed against market premium and P/E premium. The results indicate that low P/E portfolios, on average, earned higher absolute and risk-adjusted rates of return than the high P/E securities. The results reported in this paper are consistent with the view that P/E ratio information was "fully reflected" in security prices in as rapid a manner as postulated by the semi-strong form of the efficient market hypothesis. However, the behavior of security prices over the 7-year study period does not support the efficient market hypothesis. This study also indicates that the returns on growth stock (high P/E ratio) often lag behind those of value stocks (low P/E ratios). Therefore, investors can design the investment strategies on the basis of behavior of growth stock as well as value stock for enhancing their long-term performance.
https://doi.org/10.5281/zenodo.10424606References
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