The Relationship between Price-earnings Ratio and Common Stock Performance: Empirical Evidence from Hong Kong Stock Exchange

With the development of financial markets all over the world, there are many discussions on the market efficiency in academia. If the market is efficient, extra profit could not be gained by different investment strategies. In specific, there should be no excess profit gained if investors apply the P/E ratio as an indicator. Thus investigations on the relationship between P/E ratios and stock performance should provide evidence on the efficiency of market. This dissertation focuses on the Hong Kong Stock Exchange. In this research, the portfolios are formed by ranking P/E ratios, and different performance measures are calculated for the ranking portfolios. Then the results show that the relationship is positive. Moreover, the effects of tax and risk are considered in this research. After the adjustment for tax effects, the generally relationship is in accordance with that of before-tax case. When risk is discussed, it can be observed that alpha and beta for the high P/E class is larger than that for the low P/E's.