What Determines Earnings-Price Ratios: Revisited

Zarowin, Paul
June 1990
Journal of Accounting, Auditing & Finance;Summer90, Vol. 5 Issue 3, p439
Academic Journal
This article analyzes what determines earnings-price ratios. The earnings-price ratio is believed to capture the market's assessment of the equity' s risk and earnings growth prospects. Prior research, however, has found that neither risk nor growth can explain persisting cross-sectional differences in earnings-price ratios. This paper shows that persisting cross-sectional differences in forecasted long-term earnings growth are the dominant source of variation in earnings-price ratios, and that the conclusions of prior research were due to the use of realized growth as a proxy for forecasted growth, since the two measures are not highly correlated. Other factors, such as risk (beta), forecasted short-term growth, and accounting method seem to be relatively less important in determining earnings-price ratios. Using an expectational database not available to previous researchers, the research conducted here shows that the dominant determinant of the cross-sectional variation and time-series persistence of earnings/price ratios is forecasted long-term growth in earnings per share. Additional factors such as accounting method choice, forecasted short-term growth, and risk (beta), appear to be relatively unimportant in determining E/P ratios. While the significance of the forecasted growth factor reconfirms the central role of expectations in the pricing of shares, the lack of significance of beta is another piece of evidence casting doubt on its importance. This statistical result may be due to errors in variables biases, but the portfolio construction method is designed to minimize that problem. Determining which specific risk factor(s) is (are) used by the market to set share prices is, of course, an important avenue of future research.


Related Articles

  • VALUE FOCUS.  // Dow Theory Forecasts;7/2/2007, Vol. 63 Issue 27, p2 

    The article reports on the implication of target prices implied by price and earnings ratios P/E on the evaluation of the upside potential of stocks in the U.S. It is stated that implied prices show where stocks would trade if relative P/E ratios returned to historical averages and offered a...

  • What Determines Earnings-Price Ratios: Revisited.  // Journal of Accounting, Auditing & Finance;Summer90, Vol. 5 Issue 3, p455 

    This article examines the differences across firms in their earnings/price (E/P) ratios. The earnings/price ratio is considered by both academics and practitioners to be an important variable, because it is believed to capture the market's assessment of the equity's risk and earnings per share...

  • How Cheap Is Today's Market? Gandel, Stephen // Money;Jun2003, Vol. 32 Issue 6, p44 

    Can it be that stocks are still overvalued -- even after three years of punishing losses? If you measure them by the most popular yardstick, price-to-earnings ratios (P/E), the answer is yes. The stocks in the S&P 500 index have an average P/E of 31 (based on 2002 profits), which is about...

  • Conglomerate Earnings Per Share: Real and Transitory Growth. Curley, Anthony J. // Accounting Review;Jul71, Vol. 46 Issue 3, p519 

    The article focuses on conglomerate earnings per share and real and transitory growth. The evolution of complex business organizations has created conceptual and computational problems with respect to earnings per share, and research in this area is currently very active. One major area...

  • Below the Profit Line.  // Best's Review;Jul2004, Vol. 105 Issue 3, p21 

    Reports that the property/casualty insurance industry's combined ratio can drop below 100 in 2004 for the first time since 1978, when it was 97.5. Key issues of interest; Analysis of pertinent topics and relevant issues; Implications on the insurance industry.

  • MAROTTA ON MONEY. Marotta, David John // Hudson Valley Business Journal;4/30/2012, Vol. 23 Issue 18, p6 

    The article discusses issues and topics related to price-to-earnings ratio, otherwise known as P/E ratio. It states that P/E ratio is the market price per share divided by the annual earnings per share. It is a common measurement given on financial sites for a stock, index or fund. There are...

  • Still the benchmark. De Klerk, Vic // Finance Week;2/9/2004, p33 

    Reports that the price-earnings ratios of different stock exchanges in the world show which countries offer value and which do not. Share price divided by the headline earnings per share; Price-earnings ratio of shares trading on the JSE Securities Exchange in South Africa; Reasons for the 10...

  • Investment and share prices: fundamental versus speculative components Branston, Christopher B.; Groenewold, Nicolaas // North American Journal of Economics & Finance;Aug2004, Vol. 15 Issue 2, p199 

    This paper uses quarterly U.S. data from 1953(6) to 2000(6) to investigate the effects of share-price changes on investment. We focus on the distinction between speculative and fundamental components of share-price movements and we contribute to the literature by evaluating four alternative...

  • The Use of Price/Earnings Ratios. Naish, P.J. // Accountancy;Dec1966, Vol. 78 Issue 892, p827 

    The article focuses on the application of price-earnings ratio to the professional element of the investing public. It measures the current market popularity of selected stocks. The projected yield of the price-earnings ratio of twelve years purchase of earnings must be adjusted permanently with...


Read the Article


Sorry, but this item is not currently available from your library.

Try another library?
Sign out of this library

Other Topics