Variation in price earnings ratios

The price earnings ratio is one of the most widely used statistical concepts in the field of common stock investment analysis. The widespread usage of this concept stems from the convenience it affords in measuring and comparing the relative market valuation of different companies, by expressing these market values in terms of the companies’ current earnings. When the market values of a group of companies are so expressed, at some point in time or over a given period of time, it can be readily observed that the market places a different value on different companies, and even when the grouping is relatively homogeneous, for instance, a group of companies whose membership is restricted to companies that are members of the same industry and that have their shares sold on the same organized exchange, there will still exist considerable variation. The problem, then, is to find the explicit factors that are responsible for or produce the variation in market valuation, as measured by the price earnings ratio, of companies within a relatively homogeneous grouping, and to assess if the relationship between the price earnings ratios and the determinants is stable from year to year. Subjecting a specific problem in this general area to a rational analysis, in terms of measurable economic variables, is of considerable interest for the discovery of profitable investment opportunities, for the guidance of corporate policy, and for the understanding of the psychology of investor behavior.