Pe Indian Manufacturing Industry

The dependency of EPS, P/E, PEG with Expected Rate of Return: A Study on Indian Manufacturing Company

Janga Sainath Reddy

Sabyasachi Basu

Introduction

The earnings & earnings to growth model and its use to determine the expected return on equity capital is being implied by current prices and forecasts of future payoffs is comparable in certain respects to internal rate of return (IRR) calculated from market prices of a bond and the coupon payments.

P/E ratio is simply the market price of a share divided by Earnings per Share pf that particular share, is a popular mean of combining prices & forecasts of earnings implicitly for comparing expected rates of return  

On the other hand, PEG ratio is the ratio of P/E and % growth in eps, proponents of which take in account the differences in short-run earnings growth. However, some research paper doesn’t agree to the same.

But taking in account several other factor & refining the PEG ratio maybe helpful in determining the effects of various factor on the cost of equity as well as the effect of capitalized earnings on the Price of the share.

The model is based on Ohlson & Juettner-Nauroth’s (1995) and Peter D. Easton’s research work. A few modifications are made in forecasting the next period’s earnings and in case of abnormal growth.

Ohlson has pointed out that a possible limitation of these studies is many of them rely on CleanSurplus assumption in the forecast of the future book values and this assumption rarely holds practical matter. The residual income valuation model is also becoming of wide application on Wall Street.

The model talks about if the next period’s accounting earnings is equal to economic profits, then the earnings are sufficient for valuation and expected rate of return is equal to inverse of the price to expected earnings.

We have taken up 15 companies listed under NSE, India and 10 years of their data, to test our hypothesis, starting from 2002-2011; giving us an opportunity to justify our approach in the following years.

The paper follows the following process. (1) Development of a model to determine the relationship between prices, forecasts of earnings and forecasts of earnings growth. (2) Structuring the PEG ratio. (3) Dependency of P/E ratio on Capitalized earnings. (4) Valuation of a company through valuation of Equity. (5) Condition of Economic Profit equals to Abnormal Earnings

Model of PEG ratio

The Price/Earnings to Growth (PEG) is a stock's price-to-earnings ratio divided by the growth rate of its earnings for a specified time period. Price/Earnings to Growth (PEG) is a stock's price-toearnings ratio divided by the growth rate of its earnings for a specified time period. The price-toearnings ratio (P/E) is a fairly simple tool for assessing company value. The P/E ratio is popular and easy to calculate. But it has big shortcomings that investors need to consider when using it to assess stock values. This comparison of the PE ratio and the earnings growth rate as a basis for stock recommendations is captured in the PEG ratio.