International Journal of Business and Social Science

ISSN 2219-1933 (Print), 2219-6021 (Online) DOI: 10.30845/ijbss


An Idiosyncratic Explanation of Earnings-Price Ratio based on Financial Statement Analysis
Mujeeb-u-Rehman Bhayo, Mubashir Ali Khan, Raja Shahzad Shaikh

The earnings-price (E/P) ratio or alternatively the price-earnings (P/E) ratio measures the market value of a company relative to its earnings. Firms with same level of earnings, having similar size, and belonging to same industry may have differences in their E/P ratios. Because market price shows investors’ expectations about future earnings as compared to current earnings. Anderson & Brooks (2006) identified four basic variables that contribute to the explanation of E/P ratio, i.e. the year in which the E/P ratio is calculated, the size of the firm, the industry to which firm belongs, and firm specific characteristics. Subsequent to the findings of Anderson & Brooks (2006), this study attempts to identify financial ratios that can be helpful in the prediction of E/P ratio. Data of 37 companies have been taken from the same industry (i.e., Engineering), in the same year (2009), and controlling for size (by using natural log of total assets). The 36 different simple linear regression models are developed to analyze the individual factors affecting E/P ratio. Furthermore, a final regression model is prepared that simultaneously regressed the variables found significant individually. On the basis of R2 of 0.86 in the final model it is concluded that variation in E/P ratios among corporations are mostly explained by financial statements analysis. The study contributes to existing literature by giving insight on usefulness of financial statement analysis in formation of investors’ perception about firms’ value (i.e. E/P ratio). Precisely, the study serves as guide for the estimation and evaluation of firms’ future cash flow and earnings potential.

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