Haim Mozes explores whether price-earnings ratios can be effectively used in investment strategies
Professor and area chair and CPAP board member Haim Mozes co-authored “When do PE Ratios Matter?” The paper was published in the Fall 2017 edition of The Journal of Investing. The PE ratio measures a stock’s price compared to its earnings. The basic insight is that when observed PE ratios are higher than predicted PE ratios, analyst earnings forecasts tend to increase over time and that when observed PE ratios are lower than predicted, their forecasts tend to decrease over time. Therefore, what appears to be an expensive market with a high PE ratio based on its lower forecasts may actually be a market that has higher expected earnings and thus is more reasonably priced. Likewise, what appears to be a cheap market with a low PE ratio based on its higher forecasts may actually be a market that has lower expected earnings and is thus less attractively priced. As a result, the simple expectation that high observed PE ratios will result in lower future returns and that low observed PE ratios will result in higher future returns may often prove premature.