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Integrating Growth and Debt to Form P/E Investment Strategy: The Case of Electronic Industry in Taiwan
Huoshu Peng,
National Taipei University
Mei - Hui Chen, National Defense University
Ar - Wen Hong,
ABSTRACT. This paper examines the market “road wisdom” that longing low P/E portfolios but shorting high P/E portfolios can earn abnormal returns. Because growth and debt influence the calculation of P/E ratios, we control them in the analysis of P/E investment strategy. The results show that combining growth and debt with P/E can explain more variation of stock returns than using P/E only. Moreover we differentiate the practical P/E model from the expected P/E model, where the practical P/E model calculates P/E ratios using current prices and lag (past) EPS, whereas the expected P/E model uses current prices and foreword EPS. In this research, we predict that the expected P/E model can explain more variation of stock returns than the practical P/E model. Furthermore the regression coefficients of P/E in the practical model are insignificant, not confirming the prediction of the market “road wisdom.”The additional portfolio tests also exhibit mixed results.
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