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UBC Theses and Dissertations

The effect of price earnings ratio on investment decisions in trusteed pension plans Thurgood, Mervyn Frederick

Abstract

To what extent does the Price to Earnings Ratio affect the investment decisions of those who manage Trusteed Pension Funds in Canada? Secondly: What are the dangers of ignoring this index when trading in common stocks for pension plans? METHODOLOGY A complete study of Canadian pension funds and the methods of funding was made in order to get a thorough understanding of pensions in Canada. Trusteed pensions fall into two categories: - the Money Purchase Plans. - the Definite Benefit Plans. The Trusteed pension was studied from the point of view of costs and benefits, emphasizing the importance of investment yields. A study of the Price Earnings Ratio per se., was made. The study includes the examination of accounting methods used to determine earnings per share. The next step was to determine and understand the relationship of the Price Earnings Ratio to corporate growth. A further step was to determine the variables contributing to sustained corporate growth. A study of the usefulness of the Price Earnings Ratio as a valuation tool was made, based on the works of leading writers in this field. The use made of the Price Earnings Ratio by investment managers in practice was examined, as well as the whole decision making process. This was achieved through personal interviews and by questionnaires. From the information received, a summary was prepared on the decision making process and the role of the Price Earnings Ratio in that process. Various data concerning pension portfolio stocks, Price Earnings Ratios and performance, was collected and summarized in the appendices. CONCLUSIONS It was concluded that: - Considering the cost of a pension, the two most important variables are expense and earnings; of the two, investment yield or earnings has the greatest effect on reducing costs. - In determining earnings per share, not only primary E.P.S. but also fully diluted E.P.S. should be determined and compared. - The Price Earnings Ratio is a concept consistent with the present value formulae and assumes combinations of earnings, growth, duration, discount and dividend payouts. It is important that investment managers understand this. - Sustainable growth is dependent primarily on margin, turnover, leverage and taxes. - Statistical studies have shown that low Price Earnings Ratio stocks consistently outperform high Price Earnings Ratio stocks. - The decision making process places great emphasis on Fundamental Analysis and the Price Earnings Ratio. - When considering the Price Earnings Ratio, the analyst will study it in relation to the popular indices, other companies in the industry and in relation to the companies projected growth rates. RECOMMENDATIONS Unless there is strong evidence to the contrary, a stock with a low Price Earnings Ratio should be purchased in preference to a stock with a high Price Earnings Ratio, particularly if the stock meets these conditions: - A consistently high earnings record in past years. - There is no evidence of an earnings decline in future years. - The quality of management is high. - There is a relatively high margin and turnover.

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