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Earnings Growth and Value Premium: The Indian Experience

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  • T G Saji
  • S Harikumar

Abstract

Executive Summary This article addresses two main questions: Does a value premium exist in emerging market like India? If so, how pervasive is it in different market conditions? Value premium is assumed to be the difference in stock returns of undervalued and overvalued firms with a unique industry profile. The sample for the study consisted of 32 companies from the Information Technology (IT) sector, the stocks of which had traded continuously in the National Stock Exchange (NSE) during the period 2000–2010. Prowess and Capitaline constitute the sources for the firm-level financial data, and NSE web sources provide data related to share prices and market capitalization. The study involved a two-step empirical procedure: an exploratory factor analysis and a regression modelling under Ordinary Least Square (OLS) method. Exploratory factor analysis identified earnings growth and Earnings Price (E/P) rate as the prime determinants of stock returns. Expected earnings growth significantly explained E/P rate under OLS regression framework. The study then estimated normal E/P rate for the individual stock and compared the same with the actual E/P. If the actual E/P for a particular stock was greater than its estimated E/P, it was inferred that the stock was undervalued, the reverse being the case for overvaluation. The findings of this research provide empirical validity of use of E/P rate in identifying mispriced stocks in the Indian context. Undervalued stocks can produce better returns compared to overvalued stocks, and their success has been both persistent and impressive. E/P rate or P/E ratio is a valuable analytic device when properly interpreted. The publicly available E/P rate seems to possess information content and warrants an investor’s attention at the time of his portfolio formation or revision. The search process involving E/P rate suggests that the best buy would be the stock whose reported earnings per share is expected to grow most rapidly.

Suggested Citation

  • T G Saji & S Harikumar, 2015. "Earnings Growth and Value Premium: The Indian Experience," Vikalpa: The Journal for Decision Makers, , vol. 40(4), pages 444-454, December.
    • Handle: RePEc:sae:vikjou:v:40:y:2015:i:4:p:444-454
    DOI: 10.1177/0256090915608542
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    References listed on IDEAS

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    Cited by:

    1. T.G. Saji, 2018. "Financial Distress and Stock Market Failures: Lessons from Indian Realty Sector," Vision, , vol. 22(1), pages 50-60, March.

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