The Time Series Behavior And Determinants Of P/E Ratio Of Chinas Listed Company

There has been very little investigation as to how P/E ratios behave over time in Chinas stock market. Grouping common stocks into portfolios on the basis of price-earnings ratios, the author finds that the initial P/E differences among the portfolios persist up to 6 years. The time series behavior of the P/E ratio provides some insight into the nature of the factors that influence it. Some of these factors dissipate within the first three years after portfolio formation, but certain factors are still causing differences in P/E ratios through at least the sixth year after portfolio formation. The author considers six potential factors——profitability(measured by ROE), growth, risk, equity scale, industry difference and IPO P/E ratio.A significantly negative correlation is found between P/E ratio and ROE in all the years observed. The negative correlation between P/E and ROE in the year of portfolio formation implies that stocks with relatively low ROE during the year tend to have relatively high P/E ratios. This is consistent with the contention that market participants perceive that earnings contain transitory components and price stocks accordingly. Since we formed portfolios on the basis of the ratio of price to realized earnings, we expect that the portfolio with the highest P/E ratio will systematically tend to group together firms with negative transitory components and conversely for the portfolio with the lowest P/E ratio. As we find that the initial ROE differences among the portfolios persist up to 6 years, it is understandable that P/E ratio will also be negatively related to ROE in the years after portfolio formation.Future earnings growth appears to explain some of the persisting P/E differences, however, after three years of portfolio formation, earnings growth is hardly related to P/E ratio, suggesting that investors are forecasting only short-lived earnings distortions, or market participants, in determining prices, don(?) have the ability to forecast differential growth beyond three years.We use two indicators to measure the risk of stocks——the Beta coefficient and the standard deviation of earnings per share. The correlation between P/E ratio and Beta is relatively positive, on the other hand, a significantly negative correlation is found between P/E ratio and the standard deviation of EPS. The result implies that i nvestors prefer firms wi th relatively stable earnings and higher stock price volatility. Stocks with larger equity scale tend to reach lower P/E ratios and the industrial factor seems to supply little explanation for the P/E differences, neither does I PO P/E ratio.The regression results suggest that profitability, growth, the standard deviation of EPS and the equity scale are the most significant factors that cause the persisting P/E differences among listed firms in China(?) stock market. On average, these factors explain more than ninety percent of the variance of P/E ratio.