THE RELATION BETWEEN P/B RATIO, P/E RATIO AND FUTURE STOCK RETURNS IN THE FINNISH STOCK MARKET
Toponen, Antero (2011)
Toponen, Antero
2011
Kuvaus
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Tiivistelmä
This thesis investigates the relationship between P/B ratios, long-term P/E ratios and returns in Finnish stock markets. This is due to latest results that adding more years of earnings history increase the power of the P/E ratio to predict future returns. Also the recent research inactivity among these issues with Finnish data is the key motivator. Two of the most important financial ratios are examined with new features to show if there still exists opportunities to beat market index.
The existence of the anomalies is studied with constructing portfolios on the grounds of long-term P/E ratio and P/B ratio. The investigation period consider years 2002-2009 in Helsinki Stock Exchange. Yearly calculated financial ratios are divided to high and low portfolios to determine the difference in returns between high and low ratios. In addition to traditional P/E effect testing P/E ratio is calculated from 1, 3, 5 and 8 years of earnings averages to identify if the predicting power of P/E ratio increases with long-term aspect. Four different holding periods are estimated to show even a trace of a possible P/B or P/E effect.
The essential results of this paper concentrate to give suggestive results of price to book and price-earnings anomaly in Finnish stock markets. Returns for low P/B and P/E portfolios are systematically higher than the return of OMXHCAP index and particularly higher than returns for high P/B and P/E ratios. Results did not confirm the superiority of long-term P/E ratio in comparison to traditional P/E ratio. P/B ratio is often considered more stable and accurate value measure than P/E ratio but results of statistical testing cannot be interpreted in unambiguous way. In addition to these Jensen´s Alphas and Sharpe ratios were calculated to show the risk-return relationship of the constructed portfolios. Though adding more years of earnings data in the calculation of P/E ratios still there can be seen evidence of P/B and P/E anomalies in Finnish stock market. Altogether investing to low P/B and low P/E stocks with buy and hold strategy beat in any time the market return.
The existence of the anomalies is studied with constructing portfolios on the grounds of long-term P/E ratio and P/B ratio. The investigation period consider years 2002-2009 in Helsinki Stock Exchange. Yearly calculated financial ratios are divided to high and low portfolios to determine the difference in returns between high and low ratios. In addition to traditional P/E effect testing P/E ratio is calculated from 1, 3, 5 and 8 years of earnings averages to identify if the predicting power of P/E ratio increases with long-term aspect. Four different holding periods are estimated to show even a trace of a possible P/B or P/E effect.
The essential results of this paper concentrate to give suggestive results of price to book and price-earnings anomaly in Finnish stock markets. Returns for low P/B and P/E portfolios are systematically higher than the return of OMXHCAP index and particularly higher than returns for high P/B and P/E ratios. Results did not confirm the superiority of long-term P/E ratio in comparison to traditional P/E ratio. P/B ratio is often considered more stable and accurate value measure than P/E ratio but results of statistical testing cannot be interpreted in unambiguous way. In addition to these Jensen´s Alphas and Sharpe ratios were calculated to show the risk-return relationship of the constructed portfolios. Though adding more years of earnings data in the calculation of P/E ratios still there can be seen evidence of P/B and P/E anomalies in Finnish stock market. Altogether investing to low P/B and low P/E stocks with buy and hold strategy beat in any time the market return.