The relationship between capital structure, earnings growth and price earnings ratio of firms listed at the NSE

Abstract

This study was an attempt to determine if there is a relationship between the P/E ratio and the capital structure, and between the P/E ratio and earnings growth. Capital structure, price-earnings ratio and earnings growth are very important elements in the study of finance. Earnings growth refers to the change in earnings per share from year to year. The P/E ratio is the most basic and fundamental yardstick for valuing stocks (Siegel, 2002). It is obtained by dividing the market price of an ordinary share or common stock by the earnings per share. Capital structure is the way in which assets are financed (Ross et al, 1990) or it refers to the mix of debt, preferred stock and common equity with which the firm finances its operations (Brigham and Houston, 2004). In this study it is calculated by dividing non- current liabilities (debt) by shareholders’ funds. Assets can be financed by using only equity, that is ordinary shares (stocks), reserves and retained profits or by a mixture of debt and equity. Shareholders’ funds mean the same thing as equity in this work.