High PE or Low PE? Which better? – Manager Beta Project first report ﹝應選擇高市盈率還是低市盈率?﹞

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Vary types of investment funds are available in the market nowadays. People put their own saving into investment funds and willing to pay fees to the fund managers as they are all profit-desirous. People are looking for wealth growth. However, some funds perform better than one another, depending on its own combination. Project “Manager Beta” will explore ways to maximize equity growth by focusing on high quality portfolio combination. Manager Beta has an ultimate aim that our portfolio can always perform better than the market in the long term.

There are two parts in this research, dividing shares into groups. First half mainly focus on shares in different sectors, then looking correlation between different ratio and price performance. The remaining half is comparing performance between shares in different market capital size. Both researches are mainly focus on BULL period as it is always more valuable at the beginning, the reason is upward climbing is the overall trend in long term. BEAR market analyzes will be continued at later phase.
After Trump shocked victory in US president election, global market was extraordinarily in a bull mood. Therefore, it is a suitable period for comparing performance between shares. Late December will be a starting point as Hang Seng Index hit its lowest and has bounced 20% since then. FTSE100 Index and S&P500 have a pretty much the same pattern as Hang Seng Index.

Heng Seng Index
Heng Seng Index
FTSE100 Index
S&P500 Index

High PE or Low PE? Which better?

Quality comparenison between shares in a same sector could be determineded by Price-Earning ratio. Airline Service, Biotechnology and Gamble were three industries included in the research because of their diversed charateristics. People suggesested, also my current accounting lecturer, higher PE will most likely lead to a higher return in share price as buyers are more willing to bid with excess price. However, I argue that low P.E should be interpeted as undervalue. In another words, the stock is relatively “cheaper” than others in the sector. I decided to use a correlation table to demonstrate if the claim is valid as this may affect portfolio selection.

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Putting P.E. ratio in X-axis and price change in Y-axis. The data shows that 2 out of 3 bull markets, Airline Indusry Shares price chage is highly poistively related to Price to Earning ratio. The higher the P.E.ratio, the greater share price increses. We can belivie that choosing stock with high PE will be more beneficial in Airline Service.

Besides, its known that Return On Equity also a key ratio measuring different shares performance. Unfortunately, the correlation turns out very diversed when data is plugged in.

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Biotechology & pharmacy

Going through the simlilarly process in Biotech & pharmacy sector, the data turns result into the oppsite end. The Correlation between P.E. ratio and price change in Hong Kong, London and New York are -0.736, -0.651 and -0.211 respectively. Evidence suggested selecting a low PE will generate more profit. All shares included in Manger beta have top market capital in their respective markets as listed. However, we know only the fact that PE ratio and price change are negatively correlated at the moment. Further research in the future will be required for reasons behind.  Yet, same as Airline sector, ROE and price correlation seems meaningless.

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Gamble Industry

Gamble and leisure industry interestingly have a positive correlation between P.E ratio and price. Especially in the Western market, the number goes up to nearly 1 in the London Stock Exchange. This strong evidence suggested investors should always choose a high P.E ratio as the price rises quicker with higher chance.

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Market Capital

Indicator – Tracker Fund 2800.HK
 Choosing The Tracker Fund of Hong Kong as performance indicator because it is an Exchange Traded Fund designed closely corresponds to Hang Seng Index. The fund holdings are extremely close to the Hang Seng Index sectors weighted.

 

Shares sizes and time period

Around sixty stocks are divided into three groups by their market capital. Their performance had been recorded since 30th June 2016, day after BREXIT global stock crash, until 9th September, the day Hang Seng Index climbed to its peak. Hang Seng Index closed at 20794.37 on 30th Jun and closed at 24099.70 on 9th September. 16% rises in two months’ time.

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Seventeen stocks with 0-6 billion HKD market capital selected randomly. None of them perform better than The Tracker Fund of Hong Kong (2800.HK) in this bull period. The one with best relative performance Hong Kong Finance Group Ltd. (1273.HK), still fell behind by 2%. The remaining fell behind by 8-75% comparing to The Tracker Fund of Hong Kong (2800.HK), or generally speaking, the market.

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In terms of medium and large size shares, over half of them have similar performance relative to The Tracker Fund of Hong Kong (2800.HK). More than one-fourth even performs better. Evidence had suggested medium or large shares should be taken up large proportion in investors’ portfolio during bull market period. It is understood that small size share has less sensitivity to the market environment but more depends on own company incident such as right issue, share placement, switching auditor, profit warning etc.

Limitation

As P.E. ratio = Share price divided by Earning per Shares. It could be twisted in terms of accounting process. Furthermore, P.E calculation bases on past financial year’s EPS but economics environment changes time to time, company’s performance and EPS may differ from year to year. Although P.E seems to be a key ratio in comparing stocks, it is only one piece of the whole puzzle. Return on equity seems have no relation to price change in bull market.

Bias may have occurred when selecting twenty stocks out of thousands. Shares price affected after ex-dividend date during the period recorded.

In the future

This research will be continuing in 2017, correlation between PE and price will be recorded in wider and more sectors. A more solid conclusion could be made by that time.  In addition, I will research and select stocks by other technical indicator. RSI, MACD, divergence and stock Beta, trying to find relationship between them and price change. Although this require a senior level mathematics, I will try my very best continuing this research.

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(以上非投資建議)

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