November 7, 2019

The role of P/E multiples in determining investment returns

Two of the most common fallacies of investing in the stock market are:

  • P/E multiple of 10x is cheap and P/E multiple of 50x is expensive
  • During time periods when P/E multiples of great companies compress, share prices of poor quality companies will outperform those of great companies.

Let’s do a quick statistical analysis to test these two points. As shown in the exhibits that follow, the BSE100 universe in India has had no significant correlation between starting period valuations (as at the beginning of the concerned period) and subsequent long-term returns, no matter which phase of the stock market one looks at.


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