Abstract
A delayed market response to public information such as P/B or P/E ratios is still of great interest to money manager in seeking deeper understanding of equity valuations. In this study, we uncovered the investors’ under-reaction to ROE (Return on Equity), which provides further evidence interoperating the P/B and P/E anomalies. We found that, over time, a quarterly rebalanced portfolio holding the top decile highest ROE stocks will earn a risk controlled annual abnormal excess return of approximately 15.2 percent due to investors’ under-reaction. We also discovered that investors’ under-reaction to ROE diminishes with decreasing ROE level and almost vanishes at the lowest two deciles of ROE ranked portfolios. More importantly, investors have been persistently under-reacting to ROE information since 1973, especially the recent period from 1980 to 2004 during which the annual abnormal excess returns stayed at over 16 percent.
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