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An Investment Strategy Based on P/E ratios

Pettersen, Arild LU (2011) NEKK01 20102
Department of Economics
Abstract
Well-known economists as well as investors have examined anomalies on the stock exchange around the world for decades. Investors’ trying to beat the market in order to earn a quick buck or dollar is often what motivates them. With an investment strategy based merely on purchasing stocks with low price per earnings ratios it is said to be possible to beat the index. This so called price per earnings effect is such an anomaly, and is exactly what will be under scrutiny in this paper.

The purpose of this study is to examine the price per earnings effect and whether or not it is in fact possible to generate abnormal profits on the Stockholm Stock Exchange by constructing a portfolio consisting merely of stocks with low P/E ratios.
The... (More)
Well-known economists as well as investors have examined anomalies on the stock exchange around the world for decades. Investors’ trying to beat the market in order to earn a quick buck or dollar is often what motivates them. With an investment strategy based merely on purchasing stocks with low price per earnings ratios it is said to be possible to beat the index. This so called price per earnings effect is such an anomaly, and is exactly what will be under scrutiny in this paper.

The purpose of this study is to examine the price per earnings effect and whether or not it is in fact possible to generate abnormal profits on the Stockholm Stock Exchange by constructing a portfolio consisting merely of stocks with low P/E ratios.
The research question here is: “How does one make abnormal returns by taking advantage of the price per earnings effect, and did such an effect exist on the Stockholm Stock Exchange during 2000-2009?”

The P/E ratios of every stock within the large, mid and small cap on the Stockholm Stock Exchange was computed annually from 1999-2008, and then sorted from lowest to highest. A portfolio consisting of 25 stocks with the lowest ratios at the beginning of every year was constructed. The portfolio’s yearly return was calculated for 10 years, and then risk adjusted using the Jensen’s index. To examine if there existed a P/E effect, the portfolios performance was compared to the return of two different indexes mainly, OMXAFGX and SIXRX, to see if there was a significant difference in return.

After careful analysis of the results and the conducted T-test at a 1,0% risk level, the low P/E portfolio’s return proved to be statistically significant to both its comparison indices. This result answers the research question and verifies that a price earnings effect existed on the Stockholm Stock Exchange during the period 2000-2009 and that it was in fact possible to make abnormal returns. (Less)
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author
Pettersen, Arild LU
supervisor
organization
course
NEKK01 20102
year
type
M2 - Bachelor Degree
subject
keywords
P/E effect, Anomaly, Market Inefficiency, Investment Strategy, and Key Performance Indicators
language
English
id
1940581
date added to LUP
2011-05-18 14:30:30
date last changed
2011-05-18 14:30:30
@misc{1940581,
  abstract     = {Well-known economists as well as investors have examined anomalies on the stock exchange around the world for decades. Investors’ trying to beat the market in order to earn a quick buck or dollar is often what motivates them. With an investment strategy based merely on purchasing stocks with low price per earnings ratios it is said to be possible to beat the index. This so called price per earnings effect is such an anomaly, and is exactly what will be under scrutiny in this paper.

The purpose of this study is to examine the price per earnings effect and whether or not it is in fact possible to generate abnormal profits on the Stockholm Stock Exchange by constructing a portfolio consisting merely of stocks with low P/E ratios. 
The research question here is: “How does one make abnormal returns by taking advantage of the price per earnings effect, and did such an effect exist on the Stockholm Stock Exchange during 2000-2009?”

The P/E ratios of every stock within the large, mid and small cap on the Stockholm Stock Exchange was computed annually from 1999-2008, and then sorted from lowest to highest. A portfolio consisting of 25 stocks with the lowest ratios at the beginning of every year was constructed. The portfolio’s yearly return was calculated for 10 years, and then risk adjusted using the Jensen’s index. To examine if there existed a P/E effect, the portfolios performance was compared to the return of two different indexes mainly, OMXAFGX and SIXRX, to see if there was a significant difference in return.  

After careful analysis of the results and the conducted T-test at a 1,0% risk level, the low P/E portfolio’s return proved to be statistically significant to both its comparison indices. This result answers the research question and verifies that a price earnings effect existed on the Stockholm Stock Exchange during the period 2000-2009 and that it was in fact possible to make abnormal returns.},
  author       = {Pettersen, Arild},
  keyword      = {P/E effect,Anomaly,Market Inefficiency,Investment Strategy,and Key Performance Indicators},
  language     = {eng},
  note         = {Student Paper},
  title        = {An Investment Strategy Based on P/E ratios},
  year         = {2011},
}