Price to Earnings (PE) Ratio has been extensively used by financial (securities) analysts and investors as an investment tool to pick which stocks to be bought. PE Ratio gains popularity among securities analysts and investors since it is easy to calculate and understand. Thus far, many securities analysts, recommend investors to buy certain stocks if their PE Ratio is low compared to their counterparts (Tseng, 1988). Stock with low PE ratio is perceived as having cheaper current price hence expected to generate higher return in subsequent period.
Proponents of the P/E vis-à-vis stock returns have long claimed that lower P/E stocks signify higher market returns (Basu, 1977). However, mixed results of the relationship between the P/E Ratio and stock return and the lack of a consensus regarding the same show that there may be some inaccuracy with this claim.
The stocks to be used in the study are chosen from the BSE sectoral indices. We chose to select 10 stocks from each index based on market capitalization and have grouped them into two categories, i.e. stocks having low P/E and stocks with high P/E. This grouping is done on the basis of the average P/E for each index and the market return analysis will then be carried out. The present paper tries to ascertain the notion that the returns performance of equity stocks is related to their P/E ratios. The data, sample, and estimation procedures are outlined in the first part of the discussion. Empirical results are discussed in the next section, and conclusions and implications of the study figure in the end.