A growth adjusted price-earnings ratio

Abstract: The purpose of this paper is to introduce a new growth adjusted price-earnings measure (GA-P/E) and assess its efficacy as measure of value and predictor of future stock returns. Taking inspiration from the interpretation of the traditional price-earnings ratio as a period of time, the new measure computes the requisite payback period whilst accounting for earnings growth. Having derived the measure, we outline a number of its properties before conducting an extensive empirical study utilising a sorted portfolio methodology. We find that the returns of the low GA-P/E stocks exceed those of the high GA-P/E stocks, both in an absolute sense and also on a risk-adjusted basis. Furthermore, the returns from the low GA-P/E porfolio was found to exceed those of the value portfolio arising from a P/E sort on the same pool of stocks. Finally, the returns of our GA-P/E sorted porfolios were subjected to analysis by conducting regressions against the standard Fama and French risk factors.