erc/metu
INTERNATIONAL CONFERENCE IN ECONOMICS  IV
September 13-16, 2000, Ankara

P/E and Price-to-Book Ratios as Predictors of Stock Returns in Emerging Equity Markets

Kürşat Aydoğan (Bilkent University)
Güner Gürsoy (Bilkent University)

Abstract

For the practitioners in the market, it is the predictive ability, rather than ontemporaneous explanatory power, that really counts. In addition, apart from forecasting individual stock returns, stock market investors are also interested in the ability of market wide averages of variables like dividend yield, P/E and book-to-market ratios as tools in market timing in highly volatile stock markets. The objective of this paper is to investigate the ability of average P/E and book-to-market ratios to predict future stock market returns in emerging equity markets. In this paper, we initially grouped observed average P/E and price-to-book ratios (PBV) into quintiles in 19 emerging equity markets and associating them with 3-month, 6-month and 12-month future returns. Our study is confined to a group of countries widely known as "emerging equity markets" defined and monitored by International Finance Corporation (IFC) arm of the World Bank. We also perform econometric tests on the panel data of emerging equity markets for the period between 1986 to 2000. Our results indicate that both P/E and price-to-book ratios have predictive power of future return, even in the shorter time periods, hence can be used as tools in forming a market timing and asset allocation strategy in emerging equity markets.

Economic Research Center
Middle East Technical University
06531 Ankara Turkey
Phone: + 90 312 210 3044, 210 2003
Fax: +90 312 210 1244
e-mail: metuerc@metu.edu.tr