{"id":2030891,"date":"2015-07-26T11:58:43","date_gmt":"2015-07-26T06:28:43","guid":{"rendered":"http:\/\/stockviz.biz\/index.php\/?p=2030891"},"modified":"2015-07-26T11:58:43","modified_gmt":"2015-07-26T06:28:43","slug":"profiting-from-pe-ratio-obsession","status":"publish","type":"post","link":"https:\/\/stockviz.biz\/index.php\/2015\/07\/26\/profiting-from-pe-ratio-obsession\/","title":{"rendered":"Profiting from PE Ratio Obsession"},"content":{"rendered":"<h3>Background<\/h3>\n<p>We are not big fans of using the Price-to-Earnings ratio. We saw how <a href=\"https:\/\/stockviz.biz\/index.php\/2015\/07\/21\/dynamic-pe-funds\/\" target=\"_blank\">funds that use the market PE<\/a> to time the market are no better than a buy-and-hold strategy (sometimes B&amp;H performs better,) and we followed that up with how <a href=\"https:\/\/stockviz.biz\/index.php\/2015\/07\/24\/beware-of-single-factor-investing\/\" target=\"_blank\">every single &#8220;ratio&#8221; has a caveat<\/a>. And PE is the dumbest of them all.<\/p>\n<p>However, <i>if<\/i> a large group of market participants pay attention to single flawed metric, <i>then<\/i> there should be a profitable arbitrage strategy that exploits that anomaly?<\/p>\n<h3>Exploiting PE obsession<\/h3>\n<p>Researchers in the US figured out a way to do just that.<\/p>\n<div class=\"row-fluid well well-small\">\nActive investors with limited attention and capital constraints use fundamental metrics to screen and sort potential investments. Price-earnings (P\/E) ratios are extremely popular, and are typically calculated using four trailing quarters of net income. <strong>Changes in the rankings of published P\/E ratios may influence investor attention and subsequent excess returns<\/strong>. From 1974-2013, decile long-short portfolios formed on characteristics of P\/E rankings which are rebalanced monthly earn value-weighted monthly excess returns of 101 basis points with annual Sharpe ratios of 0.79. Decile long-short portfolios which are rebalanced daily earn value-weighted daily excess returns of 16.99 basis points with annual Sharpe ratios of 2.91. Excess returns are robust to size, value, profitability, investment, price momentum, earnings momentum, short-term reversals, and relative volume. <strong>Changes to a stock\u2019s P\/E ranking predicts excess returns even when the stock\u2019s P\/E ratio itself does not change.<\/strong> The return premium cannot be explained by fundamental risk, clustering of attention at round number P\/E ratios, or autocorrelation in the regressors.\n<\/div>\n<p>We haven&#8217;t tested this for the Indian market yet. But this is just too cool not to share!<\/p>\n<p>Paper: <a href=\"http:\/\/papers.ssrn.com\/sol3\/papers.cfm?abstract_id=2613157\" target=\"_blank\">Rankings of published price-earnings ratios and investor attention<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Background We are not big fans of using the Price-to-Earnings ratio. We saw how funds that use the market PE to time the market are no better than a buy-and-hold strategy (sometimes B&amp;H performs better,) and we followed that up with how every single &#8220;ratio&#8221; has a caveat. And PE is the dumbest of them &hellip; <\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[3471,9],"tags":[1270,2761],"class_list":["post-2030891","post","type-post","status-publish","format-standard","hentry","category-investing-insight","category-your-money","tag-investing","tag-quant","entry"],"_links":{"self":[{"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/posts\/2030891","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/comments?post=2030891"}],"version-history":[{"count":0,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/posts\/2030891\/revisions"}],"wp:attachment":[{"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/media?parent=2030891"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/categories?post=2030891"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/tags?post=2030891"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}