Portfolio Performance in Relation to Price Earning Ratio : A Test of Efficiency under Different Economic Conditions

Price earning ratios are widely applied by investors to make investment decisions and to determine the future behavior of stock price. This paper measures the performance of a set of portfolios which are based on P/E of stocks. The study examines the monthly price-earning ratio of BSE 100 companies, for the period June 1996 to May 2005, and three non-overlapping sub-periods (June 1996-December 1999, January 2000-December 2002, and January 2003-May 2005). The paper found no consistency between the portfolios' expected return and their corresponding P/E ratios. It is observed that the stock market failed to reflect instantaneous response pertaining to earnings information. However, during the pool and sub-periods, the relationship between portfolio expected return and market risk is found to be positive and significant. These findings question the efficient market hypothesis but hold the application of the capital asset pricing model in the Indian stock market.