A study of relationship between PE ratio and stock market investment decision in Nepal
It is quite hard to predict world economy. A piece of decision of a company or a policy of the government can adversely affect economic environment. Therefore, to make a good investment decision in the stock market, it is important to access relevant financial information. Some tools and techniques can enable shareholders or potential investors to make sound investment decision.
Price earnings (PE) ratio is one of the investment analysis tools that tell that how expensive the company’s shares are. PE ratio is simply the market value of shares divided by earning per share. For example, if a company has 10000 (market trading at $500) shares and Net profit is $200,000 then Earning per share is $20 (200,000/10,000). Therefore, PE ratio is 25 times ($500/20). A PE ratio 25 refers that investors in the stock market are willing to pay $25 for every $1 of earnings that the company generates. If a company has high PE ratio, it indicates that investors are anticipating high growth in the future. In the Australian case, average PE ratio is 15; however, some companies have high, for example, face book has 200 PE ratio.
Objectives : How does PE ratio influence on stock market investment decision to Nepalese investors
: How to compare numbers (ratio) for among companies
: Can PE ratio be a good key to judge company and make a good investment decision?
Literature Review:
Abstract: Financial analysts and investors to select stock for investment have broadly used Price to Earning (PE) Ratio. PE ratio shows the expense over per dollar earnings. Stocks with low PE ratio indicate as consisting cheaper current trading price and hence anticipating gaining higher return in the future. This research aims to show how PE ratio is the best key, which influences shareholders or potential investors to make good stock market investment decision.
Price to Earning (PE Ratio has been extensively used by investors and analysts as an effective investment tool to take stock purchase decision. Due to its easiness to calculate and understand, its popularity is growing among investors and other financial analysts. Some researches support that PE ratio is a good tool to consider while making investment in stock market. Basu’s (1977-1985) an extensive study on listed on the New York Stock Exchange (NYSE) for the period between 1957 and 1971 finds that PE ratios on average earn significantly higher and risk-adjusted rates of return. Similarly, Damodran (2006) also indicates that higher growth firms have higher PE ratio. Keith P. Anderson (2005) also indicates that the high use of PE ratio to measure expected performance of the companies. A Paper written by the Tze San Ong, YantoultraNguiYichen, Boon HengTeh (2010) explores that the PE ratio could have been employed to build successful investment strategies in predicting stock market. A linear positive slope exists between the annualized return of the KLCI and PE ratio, thus suggesting that an increase in PE ratio could have led to a subsequent rise in the KLCI. Therefore, PE ratio can be a good indicator for forecasting the future of stock market and its return.
However, Jaffe et al. (1989) discovered that stock with high PE ratio generates low return and vice versa. Later Tervino and Robortson (2002) also conclude that PE ratio can only estimate long term return not for short term and there is no significant relationship between PE ratio and stock returns in long term.
H. Solanki (Dr.) (2014) also concludes after analyzing 100 Indian listed companies that investing in low P/E stocks creates sound possibility to generate better returns. It shows that performances of least P/E stocks are much better in compare to higher P/E stocks. Wan-Ting (2013) concludes that he P/E ratio has a crucial role in the investment community and this ratio reflects the market’s expectation of future growth and firm risk
Significance contribution of research:
Theory: This research can significantly support to investment theory. Investment theory usually supports in the decision making process of selecting best investment decision. This study is also going to find out how PE ratio is a key to consider while making stock market investment decision
Practical: This study can provide more confidence to shareholders and potential investors to make the good investment decisions comparing different companies’ PE ratio rather than observing other tools, such as profitability or share price of the company.
Reference:
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