For the next 30-60 days we’ll be posting a recap research report on classic research related to quantitative value investing. This is the first part of the series. Stay tuned for a whole lot more!
Investment Performance of Common Stocks in Relation to Their Price-earnings Ratios: A Test of The Efficient Market Hypothesis
- S. Basu
- A version of the paper can be found here.
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Core Idea:Basu examines the relationship between stock returns and P/E ratios based on sample from 1957 to 1971. He finds that the Low P/E ratio portfolio earned 7% higher returns than a high P/E portfolio.
- Stocks are sorted into five equally weighted portfolios based on P/E ratios (A=highest P/E, B,C,D and E=lowest P/E). The table below shows that the highest earnings yield quintile (E) earned 16.30% on average per year compared to 9.34% by the lowest quintile (A), about 7% higher.
- Beta could not explain these return differences; in fact, the low P/E portfolios were associated with lower levels of systematic risk than the high P/E portfolios.