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The Long-Term P/E Radio

Author

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  • Keith Anderson

    (ICMA Centre, University of Reading)

  • Chris Brooks

    (ICMA Centre, University of Reading)

Abstract

The price-earnings effect has been thoroughly documented and widely studied around the world. However, it has always been calculated on the basis of the previous year's earnings. We show that the power of the effect has until now been seriously underestimated, due to taking too short-term a view of earnings. We look at all UK companies since 1975, and using the traditional P/E ratio we find the difference in average annual returns between the value and glamour deciles to be 6%, similar to other authors' findings. We almost double that gap by calculating P/E ratios using earnings averaged over the last eight years. Averaging, however, implies equal weights for each past year. We widen the gap further by optimising the weights of the past years of earnings in the P/E ratio.

Suggested Citation

  • Keith Anderson & Chris Brooks, 2005. "The Long-Term P/E Radio," ICMA Centre Discussion Papers in Finance icma-dp2005-02, Henley Business School, University of Reading.
    • Handle: RePEc:rdg:icmadp:icma-dp2005-02
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    References listed on IDEAS

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    Cited by:

    1. Keith Anderson & Chris Brooks, 2005. "Decomposing the P/E Ratio," ICMA Centre Discussion Papers in Finance icma-dp2005-03, Henley Business School, University of Reading.
    2. Keith Anderson & Chris Brooks, 2005. "The Extremes of the P/E Effect," ICMA Centre Discussion Papers in Finance icma-dp2005-04, Henley Business School, University of Reading.

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