Thesis: Price to Earnings Ratio (P/E Ratio)

Sample Thesis Paper

This ratio is the most widely used of all the Market Value Ratios. The market price of the stock of a company is divided by the earnings per share to achieve the P/E Ratio. A high P/E ratio indicates that buyers anticipate growth in the company and a low P/E Ratio means that buyers do not anticipate a high rate of growth for the company in the future (Loth 2009).

However, P/E ratio has its drawbacks when it is used as a substitute for fair value of the stock. The problem occurs when the earnings are lowered due to economic depression and P/E reflects higher value of the share when it should be relatively cheaper to buy share. Therefore a solution to use average earnings is proposed (Wilson 2008). Furthermore its criticism comes from accounting regulatory bodies that companies are often involved in creative accounting to manipulate their profit figures and hence P/E ratio for capital markets. Also two different approaches to P/E ratio have been suggested – Trailing P/E and Forward P/E. Previous uses last 12 months figures for earnings to calculate P/E ratio whereas the later approach uses future earnings projections (Ahsan 2009). The P/E Ratio is also affected by various factors as Agmon et al (1994) suggested in a research analyzing Japanese stocks;

‘the higher P/E ratios are driven by the structure of the Japanese firm (an economic and cultural attribute). Still others argue that the Japanese accounting system is tax-oriented and that reported earnings are artificially low thus leading to a high P/E ratio’ (p. 56).

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