What is it about?
Investors often use financial ratios to screen large numbers of stocks and identify those that deserve further analysis. However, commonly used measures such as the price-to-earnings (PE), price-to-book (PB), and expected earnings growth (EG) ratios have mathematical and interpretive limitations that can cause stocks to be incorrectly ranked or selected. This study examines alternative ratios designed to address these problems. In particular, we propose the earnings growth yield (EGY) as an alternative to the conventional earnings growth ratio and show that it provides more consistent interpretation and more accurate stock rankings.
Featured Image
Why is it important?
Financial ratios are widely used by investors to narrow a large universe of stocks to a manageable group for further analysis. If these ratios contain mathematical or interpretive problems, potentially attractive stocks may be overlooked while less attractive stocks may be selected. This study identifies limitations in several commonly used ratios and proposes alternatives that can improve the stock-screening process. Among these alternatives, the earnings growth yield (EGY) provides important improvements over the conventional earnings growth ratio in proportionality, numerical interpretation, and the accuracy of stock rankings.
Perspectives
The motivation for this study came from recognizing that commonly used financial ratios can have mathematical and interpretive limitations that affect how investors screen and rank stocks. We wanted to examine whether alternative measures could address these problems while remaining practical for investors. Our analysis shows that alternative ratios, particularly the earnings growth yield (EGY), can provide more consistent interpretation and more accurate stock rankings. I hope this study helps investors better understand the limitations of commonly used financial ratios and provides useful alternatives for identifying stocks for further analysis.
Dr. Hongbok Lee
Western Illinois University
Read the Original
This page is a summary of: Improved alternatives to price multiple and earnings growth ratios used by bottom-up investors, Applied Financial Economics, November 2013, Taylor & Francis,
DOI: 10.1080/09603107.2013.848028.
You can read the full text:
Contributors
The following have contributed to this page
