Investing Using PE Mean Reversion

Authored by Dr. Ruzbeh Bodhanwala FLAME University, Pune 

Every fund manager and investor wishes to earn more than the BSE Sensex return, which in technical parlance is referred to as generating alpha. There are many investing techniques using which investors try to earn excess return – one such technique is ‘mean reversion’. This technique of investing believes that every stock reverts to its long-term mean PE ratio and by selecting stocks which are trading below their long-term average PE ratio we can maximise our returns. The PE multiple (price to earnings ratio) has been one of the most popular approaches to equity valuation. The PE ratio of a company is calculated by dividing the current market price of the share with its earnings per share (EPS).