Winter Project

A PROJECT REPORT ON

“P/E RATIO” OF DIFFERENT CAPITALISATION OF STOCKS & INVESTORS PREFERENCE FOR RISK & RETURN

Submitted in partial fulfillment of the requirements for the award of the degree of POST GRADUATE DIPLOMA IN MANAGEMENT (AICTE)

By AMIT Kr. GUPTA

UNDER THE GUIDENCE OF RAKESH KUMAR (FACULTY FINANCE) ASIA PACIFIC INSTITUTE OF MANAGEMENT,NEW DELHI

CERTIFICATE

This is Certified that the project titled

“P/E

RATIO

OF DIFFERENT

CAPITALISATION OF STOCKS & INVESTORS PREFERENCE FOR RISK & RETURN”

submitted

to

ASIA PACIFIC INSTITUTE OF MANAGEMENT, NEW

DELHI in partial fulfillment of the requirement of degree of POST GRADUATE DIPLOMA IN MANAGEMENT (AICTE) is a bonafide record of work carried out by Mr. AMIT KUMAR GUPTA ID NO-2K72A05, under my supervision and guidance.

Project Guide: RAKESH KUMAR (Faculty Finance)

ASIA PACIFIC INSTITUTE OF MANAGEMENT-NEW DELHI

ACKNOWLEDGEMENT

I wish to express my gratitude to those who, in some or the other way, helped me in accomplishing

this challenging

project on

“P/E RATIO OF DIFFERENT

CAPITALISATION OF STOCKS & INVESTORS PREFERENCE FOR RISK & RETURN”. No amount of written expression can show my deepest sense of gratitude to my guide Mr.. RAKESH KUMAR (Faculty Finance), who motivated me to receive enormous amount of input and inspiration at the various stages during my project preparation and assisted me in bringing out my project in the present form. I thankfully acknowledge an active support by my Project Guide who overwhelmingly shared his knowledge with me and strengthened my conceptual framework. I am also

thankful to all the Faculties

of ASIA PACIFIC INSTITUTE OF

MANAGEMENT who supported me in various ways and enlightened me about the valuable information pertaining to my project work. Thanks to the almighty god for keeping me strong with high spirit till the end of the project. Last but not the least; I am grateful to my parents and grandparents for providing me opportunity to be a part of such reputed institute & generous consent to undertake this project.

TABLE OF CONTENTS CHAPTER 1------- INTRODUCTION CHAPTER 2-------OBJECTIVE OF STUDY CHAPTER 3--------NEED FOR STUDY CHAPTER 4--------P/E RATIO CHAPTER 5--------LARGE CAP CHAPTER 6---------MID CAP CHAPTER 7---------SMALL CAP CHAPTER 8--------DATA & RESEARCH METHODOLOGY CHAPTER 9--------FORMULATION OF HYPOTHESIS CHAPTER 10------CONCLUSION CHAPTER 11------LIMITATIONS OF THE STUDY

INTRODUCTION

Investors with different levels of risk tolerance are more satisfied with investment strategies that are better aligned with their risk preferences. Differences in investors’ personal risk tolerances mean that more risk-averse investors are personally more satisfied with a lower risk portfolio despite its lower expected returns. Less risk-averse investors are more satisfied with portfolios characterized by higher risk and higher expected returns. When defining a personal investment strategy and before making related decisions, it is important for individuals to assess their personal risk tolerances relative to other investors. Investing involves risk, and there is no way around it. Investing means that the investor is willing to incur risk in exchange for the possibility of a higher payoff. An investor’s relative risk tolerance is the primary decision in his asset allocation strategy. Individuals are not investing, unless there is a chance to lose some of or the entire price paid for a security. Rational investors expect increased returns for taking on increased risk.

True investors are all assumed to be risk-averse versus risk-seeking. Market prices of securities reflect the current risk consensus, and investors have rational expectations for positive risk-adjusted payoffs. Investing is not like traditional gambling, where the expected average payoff is negative. Differences in risk tolerances mean that more risk-averse investors are personally more satisfied with a lower risk portfolio despite its lower expected returns. Less risk-averse investors are more satisfied with portfolios characterized by higher risk and higher expected returns. Investors with different levels of risk tolerance are more satisfied by the expectations associated with investment strategies that are better aligned with their risk preferences. Everyone would like higher returns, but only some are able and willing to live with the greater risks that are associated with a potential for higher returns. However, there are no guarantees in investing. All apparent “guarantees” themselves have a price and risks. Because investing is inherently risky, individuals should understand their probable response to risk factors that actually do materialize. Risk tolerance is an issue of personal psychology and will determine whether an investor will adhere to and sustain an investment strategy during difficult times. When markets are performing poorly and fears are high, an inappropriate alignment between an individual’s personal portfolio risk or volatility and his or her tolerance for that risk or volatility can be very costly. In such circumstances, investors may take actions that are appropriate to their personal psychology. However, these actions may be highly inappropriate for the current financial market situation and their long-term financial goals and welfare. For example, some investors panic and sell when they do not have to, only to see the market recover later. Portfolios with different risk and return characteristics are simply better for different investors depending upon their tolerance for investment risk.

. II. Objective of Study Modern investment theory postulates positive and linear relationship between portfolio risk and return. The risk aversion tendency of investors makes them to demand more return for higher risk. The P/E ratio of the stock tells how much investors are willing to pay per dollar of earnings & also establishes the trade off between portfolio risk and return. A better interpretation of the P/E ratio is to see it as a reflection of the market's optimism concerning a firm's growth prospects. Indian stock market is showing great signs of perfection due to liberalization. The exposure of Foreign Institutional Investors has integrated it with the world market. It becomes imperative to see the effectiveness of portfolio formulation models in changing economic and business environment. A low P/E ratio does not necessarily mean that a company is undervalued. Rather, it could mean that the market believes the company is headed for trouble in the near future. Stocks that go down usually do so for a reason. It may be that a company has warned that earnings will come in lower than expected. This wouldn't be reflected in a trailing P/E ratio until earnings are actually released, during which time the company might look undervalued. 1. Full knowledge about the P/E ratio. 2. Differences between large cap stocks, mid cap stocks & small cap stocks. 3.

The Market P/E Ratio, Earnings Trends, and Stock Return Forecasts

4. Investor’s preference for Risk & Return.

III. Need for the Study The present study has great relevance to policy makers and investors community. To policy makers, it provides wide range of information on distribution of return and risk, and their future trends, especially, when they have been examined under different economic scenarios. And for investors, the study provides the construction of portfolios using a set of techniques. The construction of portfolios by using P/E ratio has wide implications on investments decisions. If the study is seen in the following views, it will prove very useful. 1. Growing Role of Capital Market. 2. Growing Role of Institutional Investors. 3. Increasing participation of retail investors. 4. Comparative analysis of different capital of stocks. 5. Investors preference for risk & return.

P/E RATIO The P/E ratio (price-to-earnings ratio) of a stock (also called its "P/E", "PER", "earnings multiple," or simply "multiple") is a measure of the price paid for a share relative to the annual income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income. It is a valuation ratio included in other financial ratios. The reciprocal of the PE ratio is known as the earnings yield. The earnings yield is an estimate of expected return to be earned from holding the stock if we accept certain restrictive assumptions. The price per share (numerator) is the market price of a single share of the stock. The earnings per share (denominator) is the net income of the company for the most recent 12 month period (for "Trailing P/E" or "P/E ttm," which is most common), divided by number of shares outstanding. The P/E ratio can also be calculated by dividing the company's market capitalization by its total annual earnings. For example, if stock A is trading at $24 and the earnings per share for the most recent 12 month period is $3, then stock A has a P/E ratio of 24/3 or 8. Put another way, the purchaser of stock A is paying $8 for every dollar of earnings. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as Not applicable or "N/A"); sometimes, however, a negative P/E ratio may be shown. By comparing price and earnings per share for a company, one can analyze the market's stock valuation of a company and its shares relative to the income the company is actually generating. Investors can use the P/E ratio to compare the value of stocks: if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies, and time periods may be misleading.

In ordinary periods, most stocks trade between a 10-25 P/E ratio. Stocks with higher forecast earnings growth will usually have a higher P/E, and those expected to have lower earnings growth will in most cases have a lower P/E.

Determining share prices Share prices in a publicly traded company are determined by market supply and demand, and thus depend upon the expectations of buyers and sellers. Among these are: • • •

The company's future and recent performance, including potential growth; Perceived risk, including risk due to high leverage; Prospects for companies of this type, the market sector.

By dividing the price of one share in a company by the profits earned by the company per share, you arrive at the P/E ratio. If earnings move up proportionally with share prices (or vice versa) the ratio stays the same. But if stock prices gain in value and earnings remain the same or go down, the P/E rises. The earnings figure used is the most recently available, although this figure may be out of date and may not necessarily reflect the current position of the company. This is often referred to as a 'trailing P/E', because it involves taking earnings from the last four quarters The price earning multiple is sometimes called the price earnings ratio.

Other related measures The forward P/E uses the estimated earnings going forward twelve months. P/E10 uses average earnings for the past 10 years. There is a view that the average earnings for a 20 year period remains largely constant, thus using P/E10 will reduce the noise in the data. The P/E ratio relates to the equity value. A similar measure can be defined for real estate, see Case-Shiller index. PEG ratio is obtained by dividing the P/E ratio by the annual earnings growth rate. It is considered a form of normalization because higher growth rate should cause higher P/E. The similar ratio on the enterprise value level is EV/EBITDA Enterprise value divided by the EBITDA. Present Value of Growth Opportunities (PVGO) is another alternative method for stock valuation. Present value of growth opportunities is calculated by finding the

difference between price of equity with constant growth and price of equity with no growth. PVGO = P(Growth) - P(No growth) = [D1/(r-g)] - E/r where P = Price of equity D1 = Dividend for next period r = Cost of Capital E = Earning on equity Since the Price/Earnings (P/E) Multiple is 'Price per share / Earnings per share' it can be written as P0 / E1 = 1/r [ 1+ (PVGO/(E1/r))] Thus, as PVGO rises, the P/E ratio rises.

Dividend Yield Publicly traded companies often make periodic quarterly or yearly cash payments to their owners, the shareholders, in direct proportion to the number of shares held. According to US law, such payments can only be made out of current earnings or out of reserves (earnings retained from previous years). The company decides on the total payment and this is divided by the number of shares. The resulting dividend is an amount of cash per share. The dividend yield is the dividend paid in the last accounting year divided by the current share price. If a stock paid out $5 per share in cash dividends to its shareholders last year, and its price is currently $50, then it has a dividend yield of 10%. Historically, at severely high P/E ratios (such as over 100x), a stock has NO (0.0%) or negligible dividend yield. With a P/E ratio over 100x, and supposing a portion of earnings is paid as dividend, it would take over a century to earn back the purchase price. Such stocks are extremely overvalued, unless a huge growth of earnings in the next years is expected.

Earnings yield The reverse (or reciprocal) of the P/E is the E/P, also known as the earnings yield. The earnings yield is quoted as a percentage, and is useful in comparing a stock, sector, or the market's valuation relative to bonds. The earnings yield is also the cost to a publicly traded company of raising expansion capital through the issuance of stock.

Interpretation The average U.S. equity P/E ratio from 1900 to 2005 is 14 (or 16, depending on whether the geometric mean or the arithmetic mean, respectively, is used to average). An oversimplified interpretation would conclude that it takes about 14 years to recoup the price paid for a stock [not including any income from the reinvestment of dividends]. Normally, stocks with high earning growth are traded at higher P/E values. From the previous example, stock A, trading at $24 per share, may be expected to earn $6 per share the next year. Then the forward P/E ratio is $24/6 = 4. So, you are paying $4 for every one dollar of earnings, which makes the stock more attractive than it was the previous year. The P/E ratio implicitly incorporates the perceived riskiness of a given company's future earnings. For a stock purchaser, this risk includes the possibility of bankruptcy. For companies with high leverage (that is, high levels of debt), the risk of bankruptcy will be higher than for other companies. Assuming the effect of leverage is positive, the earnings for a highly-leveraged company will also be higher. In principle, the P/E ratio incorporates this information, and different P/E ratios may reflect the structure of the balance sheet. Variations on the standard trailing and forward P/E ratios are common. Generally, alternative P/E measures substitute different measures of earnings, such as rolling averages over longer periods of time (to "smooth" volatile earnings, for example)[6], or "corrected" earnings figures that exclude certain extraordinary events or one-off gains or losses. The definitions may not be standardized. Various interpretations of a particular P/E ratio are possible, and the historical table below is just indicative and cannot be a guide, as current P/E ratios should be compared to current real interest rates (see Fed model): A company with no earnings has an undefined P/E ratio. By convention, companies with losses (negative earnings) are usually treated as having an N/A undefined P/E ratio, although a negative P/E ratio can be mathematically determined.

Either the stock is undervalued or the company's earnings are thought to be 0–10 in decline. Alternatively, current earnings may be substantially above historic trends or the company may have profited from selling assets.

10–17 For many companies a P/E ratio in this range may be considered fair value.

17–25 Either the stock is overvalued or the company's earnings have increased since

the last earnings figure was published. The stock may also be a growth stock with earnings expected to increase substantially in future.

25+

A company whose shares have a very high P/E may have high expected future growth in earnings or the stock may be the subject of a speculative bubble.

It is usually not enough to look at the P/E ratio of one company and determine its status. Usually, an analyst will look at a company's P/E ratio compared to the industry the company is in, the sector the company is in, as well as the overall market (for example the S&P 500 if it is listed in a US exchange). Sites such as Reuters offer these comparisons in one table. Example of RHT Often, comparisons will also be made between quarterly and annual data. Only after a comparison with the industry, sector, and market can an analyst determine whether a P/E ratio is high or low with the above mentioned distinctions (i.e., undervaluation, over valuation, fair valuation, etc). Using Discounted cash flow analysis, the impact of earnings growth and inflation can be evaluated. The on-line calculator at Moneychimp[7] allows one to evaluate the "fair P/E ratio". Using constant historical earnings growth rate of 3.8 and post-war S&P 500 returns of 11% (including 4% inflation) as the discount rate, the fair P/E is obtained as 14.42. A stock growing at 10% for next 5 years would have a fair P/E of 18.65.

The Market P/E To calculate the P/E ratio of a market index such as the S&P 500, it is not accurate to take the "simple average" of the P/Es of all stock constituents. The preferred and accurate method is to calculate the weighted average. In this case, each stock's underlying market cap (price multiplied by number of shares in issue) is summed to give the total value in terms of market capitalization for the whole market index. The same method is computed for each stock's underlying net earnings (earnings per share multiplied by number of shares in issue). In this case, the total of all net earnings is computed and this gives the total earnings for the whole market index. The final stage is to divide the total market capitalization by the total earnings to give the market P/E ratio. The reason for using the weighted average method rather than 'simple' average can best be described by the fact that the smaller constituents have less of an impact on the overall market index. For example, if a market index is composed of companies X and Y, both of which have the same P/E ratio (which causes the market index to have the same ratio as well) but X has a 9 times greater market cap than Y, then a percentage drop in earnings per share in Y should yield a much smaller effect in the market index than the same percentage drop in earnings per share in X. A variation that is often used is to exclude companies with negative earnings from the sample - especially when looking at sub-indices with a lower number of stocks where companies with negative earnings will distort the figures.

In Stocks for the Long Run, Jeremy Siegel argues that the earnings yield is a good indicator of the market performance on the long run. The average P/E for the past 130 years has been 14.45 (i.e. earnings yield 6.8%). Shiller has argued that the mean P/E has risen from 12 to about 21 during 1920 to 2003[8]. Matt Blackman has examined a trading strategy using P/E ratio involving staying out of the market when P/E's 2 year SMA falls below 5 year SMA. It resulted in capturing 91% of the gain by staying in the market for only 42% of the time.

Historical vs. Projected Earnings A distinction has to be made between the fundamental (or intrinsic) P/E and the way we actually compute P/Es. The fundamental or intrinsic P/E examines earnings forecasts. That is what was done in the analogy above. In reality, we actually compute P/Es using the latest 12 month corporate earnings. Using past earnings introduces a temporal mismatch, but it is felt that having this mismatch is better than using future earnings, since future earnings estimates are notoriously inaccurate and susceptible to deliberate manipulation. On the other hand, just because a stock is trading at a low fundamental P/E is not an indicator that the stock is undervalued. A stock may be trading at a low P/E because the investors are less optimistic about the future earnings from the stock. Thus, one way to get a fair comparison between stocks is to use their primary P/E. This primary P/E is based on the earnings projections made for the next years to which a discount calculation is applied.

The P/E Concept in Business Culture The P/E ratio of a company is a significant focus for management in many companies and industries. This is because management is primarily paid with their company's stock (a form of payment that is supposed to align the interests of management with the interests of other stock holders), in order to increase the stock price. The stock price can increase in one of two ways: either through improved earnings or through an improved multiple that the market assigns to those earnings. As mentioned earlier, a higher P/E ratio is the result of a sustainable advantage that allows a company to grow earnings over time (i.e., investors are paying for their peace of mind). Efforts by management to convince investors that their companies do have a sustainable advantage have had profound effects on business: •

The primary motivation for building conglomerates is to diversify earnings so that they go up steadily over time.

•

•

The choice of businesses which are enhanced or closed down or sold within these conglomerates is often made based on their perceived volatility, regardless of the absolute level of profits or profit margins. One of the main genres of financial fraud, "slush fund accounting" (hiding excess earnings in good years to cover for losses in lean years), is designed to create the image that the company always slowly but steadily increases profits, with the goal to increase the P/E ratio.

These and many other actions used by companies to structure themselves to be perceived as commanding a higher P/E ratio can seem counterintuitive to some, because while they may decrease the absolute level of profits they are designed to increase the stock price. Thus, in this situation, maximizing the stock price acts as a perverse incentive.

Where P/E Does Not Apply? When looking at newer companies such as Internet start-ups or bio-techs, there is often no net income, so there are no earnings per share. In these cases the P/E ratio does not apply, forcing analysts to turn to other measures. The most common alternative ratios include: revenues per share, gross income per share or cash flow per share. All these ratios take the relevant number from an income statement, divide them by the number of shares and then divide the stock price by this number. For example if XYZ Corp. has sales of $1 billion and 100 million shares outstanding, then the revenue per share is $10. If the stock is trading at $90 per share, the price to revenue ratio is 9x. There are flaws in taking these ratios, but in the absence of a meaningful P/E Ratio, they are a good place to start.

The Market P/E Ratio, Earnings Trends, and Stock Return Forecasts:This is an analysis of periods characterized by high price/equity ratios, using measures of the market P/E based on both one-year trailing earnings and ten-year smoothed earnings. High P/E periods are preceded by accelerating equity returns and declines in both nominal interest rates and stock market volatility. Stock returns following a high P/E period are marginally higher when earnings growth remains strong and interest rates continue falling. Even when these mitigating factors are in place, however, real returns are appreciably lower for decades following high levels of the market P/E ratio. The worst case scenario for future equity returns occurs when P/E ratios expand during periods of strong earnings growth. Once earnings growth slows, equities are left profoundly overvalued, which leads to prolonged periods of low and sometimes negative

real returns. The findings suggest that U.S. equities are currently priced to deliver real returns that are positive, but well below their historical average

Problems With The P/E:So far we've learned that in the right circumstances, the P/E ratio can help us determine whether a company is over- or under-valued. But P/E analysis is only valid in certain circumstances and it has its pitfalls. Some factors that can undermine the usefulness of the P/E ratio include: Accounting Earnings is an accounting figure that includes non-cash items. Furthermore, the guidelines for determining earnings are governed by accounting rules (Generally Accepted Accounting Principles (GAAP)) that change over time and are different in each country. To complicate matters, EPS can be twisted, prodded and squeezed into various numbers depending on how you do the books. The result is that we often don't know whether we are comparing the same figures, or apples to oranges. Inflation In times of high inflation, inventory and depreciation costs tend to be understated because the replacement costs of goods and equipment rise with the general level of prices. Thus, P/E ratios tend to be lower during times of high inflation because the market sees earnings as artificially distorted upwards. As with all ratios, it's more valuable to look at the P/E over time in order to determine the trend. Inflation makes this difficult, as past information is less useful today. Many Interpretations A low P/E ratio does not necessarily mean that a company is undervalued. Rather, it could mean that the market believes the company is headed for trouble in the near future. Stocks that go down usually do so for a reason. It may be that a company has warned that earnings will come in lower than expected. This wouldn't be reflected in a trailing P/E ratio until earnings are actually released, during which time the company might look undervalued.

P/E Ratio: It's Not A Crystal Ball:What goes up ... well, sometimes it stays up for an awfully long time. A common mistake among beginning investors is the short selling of stocks because they have a high P/E ratio. If you aren't familiar with short selling, it's an investing technique by which an investor can make money when a shorted security falls in value. First of all, we believe that novice investors shouldn't be shorting. Secondly, you can get into a lot of trouble by valuing stocks using only simple indicators such as the P/E ratio. Although a high P/E ratio could mean that a stock is overvalued, there is no guarantee that it will come back down anytime soon. On the flip side, even if a stock is undervalued, it could take years for the market to value it in the proper way. Security analysis requires a great deal more than understanding a few ratios. While the P/E is one part of the puzzle, it's definitely not a crystal ball.

P/E RATIO CONCLUSION

• • • • • • • • • • •

The P/E ratio is the current stock price of a company divided by its earnings per share (EPS). Variations exist using trailing EPS, forward EPS, or an average of the two. Historically, the average P/E ratio in the market has been around 15-25. Theoretically, a stock's P/E tells us how much investors are willing to pay per dollar of earnings. A better interpretation of the P/E ratio is to see it as a reflection of the market's optimism concerning a firm's growth prospects. The P/E ratio is a much better indicator of a stock's value than the market price alone. In general, it's difficult to say whether a particular P/E is high or low without taking into account growth rates and the industry. Changes in accounting rules as well as differing EPS calculations can make analysis difficult. P/E ratios are generally lower during times of high inflation. There are many explanations as to why a company has a low P/E. Don't base any buy or sell decision on the multiple alone.

LARGE CAP

Large cap is an investing abbreviation for Large Capitalization. It is a reference to the market value or "capitalization" of a stock listed on public exchange such as the Dow Jones stock exchange. A stock or company is said to be large cap if it's market value is between 10 billion and 200 billion dollars. The limits though are somewhat arbitrary and will vary depending on who you ask. General Electric (GE) is an excellent example of a large cap stock or company. Large cap stocks are generally considered safe stocks. The sheer size of these companies tends to make the stock price fairly stable. It is unusual for them to experience significant growth or to see large declines in the value of their stock price. For this reason, many investors tend to park their money in large caps during times of uncertainty or unrest in the stock markets. However, not all large cap companies can be considered safe. Even among the stocks considered safe there are better choices than others. An intelligent and diligent investor will still review the specific company's financial statements and perhaps the industry outlook before investing in a particular stock. It is also possible to invest in large caps using mutual funds that specialize in large cap companies. There are many large cap mutual funds to choose from. Most "blue chip" companies are also large cap companies so a mutual fund that invests in blue chip companies is also a large cap mutual fund. An even easier way to invest in large cap funds is to purchase Dow Jones index funds. Only large companies tend to be listed on the Dow Jones stock exchange, also know as the senior exchange. An index fund invests equally in the companies making up that index. So a Dow Jones 30 index fund will invest equally in the 30 companies that make up the Dow Jones 30 index. There are also large cap index funds available that will invest in large cap companies that are listed on other exchanges.

A nationally recognized, well-established and financially sound company. Blue chips generally sell high-quality, widely accepted products and services. Blue chip companies are known to weather downturns and operate profitably in the face of adverse economic conditions, which helps to contribute to their long record of stable and reliable growth. The name "blue chip" came about because in the game of poker the blue chips have the highest value. Blue chip stocks are seen as a less volatile investment than owning shares in companies without blue chip status because blue chips have an institutional status in the economy. Investors may buy blue chip companies to provide steady growth in their portfolios. The stock price of a blue chip usually closely follows the S&P 500.

MID CAP

Market capitalization ranks stocks into a number of distinct groups. Mid cap stocks are in the middle rank and represent companies whose total market capitalization is between 2 billion and 10 billion US dollars (USD). Market capitalization is the product of the stock price and the number of stock shares issued, so if XYZ company has issued one billion shares and the stock price is 3 USD, then its market capitalization is 3 billion USD and XYZ company is a mid cap company. Its stock shares would be considered mid cap stocks. This is important when considering an investment in a particular company. Each rank has certain stereotypical features that you can look for in the mid cap stock under consideration. Mid cap stocks are more risky than large cap stocks and less risky than small cap stocks. Generally, risk of company failure decreases as the company increases in size. However, a mid cap stock also has better potential for growth than a large cap company. A very large company may have completely saturated its market; while a mid cap company may have room to grow into a large cap company. So when considering an investment in a mid cap stock, you are basically trying to decide if the mid cap stock in question has the potential to grow into a large cap stock. If you are right and make the investment, you will have a successful investment. If you do not like the idea of researching individual companies, you can still invest in mid cap stocks using mutual funds. There are many mutual funds that specialize in mid cap stocks. Investors in mid cap funds expect to achieve greater returns over the long run than those investing in large cap funds. However, the returns may be much more volatile over

the short term. This means that if you check your portfolio value every week or month, the investment in mid cap stocks may be up a large amount one week and down a small amount the next time you check, while the large cap stock will be up a small amount every time. Over time however, you will expect your mid cap stocks to have a larger return than the large cap stock. Mid cap stocks are usually growth stocks, and while growth stocks are expected by many to outperform a mature or large cap stock, this is not always the case. Ultimately, the decision to invest in mid cap stock comes down to individual investment style and preference.

SMALL CAP The meanings of "big cap" and "small cap" are generally understood by their names: bigcap stocks are shares of larger companies and small-cap stocks are shares of smaller companies. Labels like these, however, are often misleading. If you don't realize how big "small-cap" stocks have become, you'll miss some good investment opportunities. Small-cap stocks are often cited as good investments due to their low valuations and potential to grow into big-cap stocks, but the definition of small cap has changed over time. What was considered a big-cap stock in 1980 is a small-cap stock today. This article will define the "caps" and provide additional information that will help investors understand terms that are often taken for granted. First, we need to define "cap", which refers to market capitalization and is calculated by multiplying the price of a stock by the number of shares outstanding. Generally speaking, this represents the market's estimate of the "value" of the company; however, it should be noted that while this is the common conception of market capitalization, to calculate the total market value of a company, you actually need to add the market value of any of the company's publicly traded bonds. Big-cap stocks refer to the largest publicly traded companies like General Electric (NYSE: GE) and IBM (NYSE: IBM). These are also called the blue chip stocks. "Big" has also been believed to have less risk while "small" has implied more risk, but, as evidenced by Enron (NYSE: ENE), this is not a good assumption to make. It is true, however, that the bigger they are, the harder they fall. The definition of big/large cap and small cap differ slightly between the brokerage houses and has changed over time. The differences between the brokerage definitions are relatively superficial and only matter for the companies that lie on the edges. The classification is important for borderline companies because mutual funds use it to determine which stocks to buy. The current approximate definitions are as follows:Big Cap - Market cap of $10 billion and greater

Mid Cap - $2 billion to $10 billion Small Cap - $300 million to $2 billion Micro Cap - $50 million to $300 million Nano Cap - Under $50 million

These categories have increased over time along with the market indexes. In the early 1980s, a big-cap stock had a market cap of $1 billion. Today that size is viewed as small. It remains to be seen if these definitions also deflate when the market does. The big-cap stocks get most of Wall Street's attention because that is where the lucrative investment banking business is. These, however, represent a very small minority of publicly traded stocks. The majority of stocks are found in the smaller classifications, and this is where the values are. To prove this we examined Baseline's database of 10,721 stocks and found that 88% of the stocks were in the smaller classifications. Note the new category that shows how big "big" has become.

Data and Research Methodology The economic and business environment is rapidly changing due to liberalization and globalization of economy. It is imperative to see the implication of P/E ratio in this changing environment. For the analysis, the P/E ratio of large cap stocks, mid cap stocks & small cap stocks of the BSE 30 (2000-2007) companies have been taken. All the data has been taken from a database PROWESS, which is maintained by CMIE Ltd. It represents all the stocks categories including large cap, mid cap and small cap. The study period is ranges from 1st January 2000 to 31st December 2007. The study period marks mixed set of economic environment throughout. It involves various three economic phases in Indian Economy. In the recession phase ranging from Jan. 2000 through Dec. 2002, Indian economy grew by an average growth rate of 4.7 percent. It is followed by high growth phase ranging from Jan. 2003 through May 2005 with average growth rate of 7.7 percent. Again from Jan 2006- Dec 2007 economy grew more by 9.5%. Therefore, the findings of the study can not be said to be biased. These are important for Investors preference for risk & return point of view. Sensex closing prices have also been taken from Jan2000 to Dec2007 & there returns have been calculated.

The study involves the use of extensive use of statistical tools like Intercept (alpha),

Slope (beta), Expected Return (α+β*y), where y is the risk free rate of return and I have taken it to e 2%, Return of companies have also been calculated ((Pt-Pt-1)/Pt),Standard Deviation. P/E ratios of large cap (30), mid cap (30) & small cap (30) companies have also been taken. All the calculations have been done on Microsoft excel sheet. Then on new excel sheets all alpha, beta, expected return, standard deviation, & P/E ratio of all the companies along with their names have been shown with average of all parameters.

DETAILS OF LARGE CAP COMPANIES P/E RATIO A B B Ltd. A C C Ltd. Aban Offshore Ltd. Adani Enterprises Ltd. Aditya Birla Nuvo Ltd. Ambuja Cements Ltd. Ashok Leyland Ltd. Axis Bank Ltd. Bank Of Baroda Bank Of India Bharat Heavy Electricals Ltd. Bharat Petroleum Corpn. Ltd. Essar Oil Ltd. G A I L (India) Ltd. Grasim Industries Ltd. H C L Technologies Ltd. Hero Honda Motors Ltd. Hindalco Industries Ltd. Hindustan Petroleum Corpn. Ltd. I C I C I Bank Ltd. I T C Ltd. Indian Hotels Co. Ltd. Indian Oil Corpn. Ltd. Industrial Development Bank Of India Ltd. Infosys Technologies Ltd. Jindal Steel & Power Ltd. Kotak Mahindra Bank Ltd. Larsen & Toubro Ltd. Mahanagar Telephone Nigam Ltd.

STANDEV

ALPHA

BETA

EXPECTED RETURN

30.26 10.76 26.43 17.66 22.004 17.07 11.87 13.38 6.53 6.26 17.49 8.49 -41.07 7.74 13.06 36.19 14.28 9.24 6.8 24.36 6.72 20.36 37.37

14.13 12.19 21.48 30.78 13.03 13.36 17.56 14.33 13.95 13.94 13.04 13.95 44.51 11.08 11.49 15.52 12.68 13.902 14.57 13.96 13.098 14.29 12.45

1.408 0.7499 6.65 3.303 2.89 -0.37 -0.12 2.87 1.13 2.21 1.86 -0.12 8.89 1.22 1.35 -2.55 -0.53 -1.13 0.33 1.309 -0.03 -0.16 0.399

1.0999 1.09 0.88 0.82 0.74 0.85 1.03 1.47 1.17 1.15 1.14 0.894 -0.596 1.04 1.03 1.22 0.83 1.02 0.892 1.1107 0.52 0.94 0.92

3.608 2.93 8.39 4.93 4.37 1.33 1.94 4.96 3.47 4.49 4.13 1.68 7.707 3.29 3.41 -0.12 1.132 0.8992 2.106 3.53 1.012 1.72 2.24

-4.39 47.85 6.86 46.27 23.72 11.08

18.39 14.64 21.194 17.69 14.88 12.77

0.82 -1.68 3.66 1.77 1.209 -1.29

1.34 0.98 1.46 1.09 1.42 1.03

3.495 0.29 6.57 3.95 4.04 0.77

Mahindra & Mahindra Ltd. AVERAGE DETAILS OF LARGE CAP STOCKS

16.04 15.6895

15.06 16.13

-0.25 1.19326

1.78 1.012

EXPECTED RETURN 4.08 0.74 1.16 6 2.22 1.13 3.58 3.35 5.03 0.6

DETAILS OF MID CAP COMPANIES DETAILS OF MID CAP STOCKS

Ador Welding Ltd. Abbott India Ltd. Aftek Ltd. Aegis Logistics Ltd. Agro Dutch Inds. Ltd. Alembic Ltd. Alok Industries Ltd. Amara Raja Batteries Ltd. Andhra Cements Ltd. Andhra Pradesh Paper Mills Ltd. Ansal Housing & Construction Ltd. Apar Industries Ltd. Archies Ltd. Arvind Ltd. Asian Electronics Ltd. Atul Ltd. Automotive Axles Ltd. B P L Ltd. Bajaj Auto Finance Ltd. Bajaj Electricals Ltd. Balkrishna Industries Ltd. Bannari Amman Sugars Ltd. Bayer Cropscience Ltd. Bharat Bijlee Ltd. C M C Ltd. Caprihans India Ltd.

P/E RATIO 10.81 8.62 6.66 21.44 4.57 8.907 5.92 -11.93 7.36 6.63

STANDEV 15.16 9.55 26.77 21.75 24.85 20.46 22.53 21.791 27.115 16.37

ALPHA 2.64 -0.4 -2.65 2.75 -0.86 -1.4 0.97 0.94 2.52 -0.55

BETA 0.72 0.57 1.9 1.63 1.54 1.27 1.307 1.205 1.26 0.58

6.06 11.796 16.599 11.29 0.59 13.43 -0.094 8.53 3.53 3.89 8.76 12.87 11.18 -6.84 8.33 11.44

28.97 17.89 20.28 17.006 24.85 16.86 14.723 19.82 10.79 25.05 18.17 15.04 17.808 24.97 18.504 22.665

4.43 2.24 -1.9 1.282 2.23 1.13 1.75 -1.2 2.08 4.18 3.09 1.019 -0.69 4.34 0.68 2.66

1.76 1.23 1.52 0.925 1.54 1.16 0.82 1.07 0.706 0.595 0.99 1.24 0.99 1.45 0.84 0.75

7.94 4.69 1.14 3.14 5.28 3.43 3.39 0.93 3.49 5.37 5.05 3.49 1.3 7.23 2.35 4.14

2.12 3.146307

Ceat Ltd. Champagne Indage Ltd. Cholamandalam D B S Finance Ltd. Cosmo Films Ltd. AVERAGE

14.17 18.08

18.299 32.438

1.08 4.05

0.98 1.599

3.04 7.25

9.27 7.35 7.97393

13.07 22.03 20.186

1.73 3.2 1.378

0.81 0.543 1.117

3.35 4.25 3.6

BETA 0.17 0.204 -0.07 0.29 0.28 0.22 0.14 0.17 0.38 0.55 -0.005 -0.12 0.8 0.04 0.32 0.19 0.27 0.196 -0.3 0.53 0.32 0.27 0.02 0.02 -0.14

ER 2.6 1.5 2.02 1.37 1.23 -0.05 -0.16 1.15 1.34 0.52 4.96 1.33 4.27 0.36 2.24 2.09 0.44 1.504 6.39 1.297 1.28 2.76 -0.58 0.45 1.66

DETAILS OF SMALL CAP COMPANIES

DETAILS OF SMALL CAP STOCKS

A B C India Ltd. A B G Infralogistics Ltd. Aarti Drugs Ltd. Ador Fontech Ltd. Ador Welding Ltd. Advanced Micronic Devices Ltd. Advent Computer Services Ltd. Aegis Logistics Ltd. Agro Dutch Inds. Ltd. Agro Tech Foods Ltd. Ahlcon Parenterals (India) Ltd. Ahmedabad Steelcraft Ltd. Ahmednagar Forgings Ltd. Aftek Ltd. Aimco Pesticides Ltd. Albert David Ltd. Alembic Ltd. Alfa Laval (India) Ltd. Alfavision Overseas (India) Ltd. Alkyl Amines Chemicals Ltd. Alok Industries Ltd. Alphageo (India) Ltd. Alps Industries Ltd. Amara Raja Batteries Ltd. Ambalal Sarabhai Enterprises

P/E RATIO 10.42 5.91 6.38 5.99 8.62 19.05 17.14 6.66 21.44 4.57 19.9 6.3 -6.62 10.85 3.45 -3.17 8.907 15.898 22.09 8.02 5.92 9.6 6.2 10.5 -2.3

STANDEV 22.75 15.79 13.84 12.63 7.7 16.59 27.6 12.94 22.55 12.82 30.06 13.9 24.77 19.58 23.6 15.3 11.77 7.88 44.03 15.93 23.56 22.71 13.96 13.96 25.09

ALPHA 2.27 1.09 2.15 0.797 0.68 -0.48 -0.44 0.83 0.58 -0.58 4.97 1.56 2.86 0.29 1.6 1.73 -0.09 1.12 6.98 0.26 0.65 2.19 -0.6 0.409 1.94

Ltd. Amforge Industries Ltd. Amit Spinning Inds. Ltd. Amtek Auto Ltd. AVERAGE

1.59 -7.78 16.53

22.29 18.04 14.16

8.28804

18.778571

3.44 1.34 3.89 1.4798 6

0.719 0.18 -0.57

4.87 1.69 2.76

0.18121

1.832

Formulation of Hypothesis ( H0:

Return of High P/E stocks is not High.

1) H1: Return of High P/E stocks is significantly High. For analysis of mid cap stocks, the hypothesis are:(2) H0: Return of moderate P/E stocks is not moderately high. H1: Return of moderate P/E stocks is moderately high. For the analysis of small cap stocks, the hypothesis are: (3) H0: Return of Low P/E stocks is not slightly high. H1:

Return of Low P/E stocks is slightly high.

VI. Limitation of the Study The research is based on secondary data wherein BSE 30 companies have been examined. It does not include any questionnaire or other kind of primary data. It is based on limited time period ranging from Jan 2000 through Dec 2007, and in some cases full observations of all stocks for the study period are not available. However, a proper adjustment has been made to neutralize the effect of non availability. In the study, the return has been calculated by using the P/E ratio of BSE 30. In calculation of return dividend yield has been ignored. It is worth mentioning here that dividend yield is not significant in developing countries like India and so it can not affect the relative return of a stock. Therefore, calculation of return of stock involves the market appreciation and depreciation.