By |Published On: October 2nd, 2014|Categories: Research Insights, Value Investing Research|

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

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.

Alpha Highlight:

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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