Analysis of P/E ratios and interest rates

Abstract

Criticizes previous research on price/earnings ratios (PER) for neglecting their historical links with interest rates and analyses the causal links between interest ratres and the PERs of the Toronto Stock Exchange 300 Index (TSE300) and of seven major Canadian industries 1965‐1997. Explains the methodology and identifies three “distinct PER regimes”: 1965‐1974 (average PER 17.17), 1975‐1982 (average PER 8.92) and 1983‐1997 (average PER 17.2 with a higher standard deviation). Looks at the economic conditions for each period and suggests that current PERs “may not be too high”. Finds a negative correlation between PERs and treasury bill rates, differing between industries; and that the bill rate explains 95 per cent of PER variation for the TSE300, although it is not significant for the gold and silver industry. Adds that divided payout ratios and lower investor risk aversion are positively related to PERs, but that growth rate has a more variable influence. Summarizes the findings and their implications for PER forecasters.

Citation

Amoako‐Adu, B. and Smith, B. (2002), "Analysis of P/E ratios and interest rates", Managerial Finance, Vol. 28 No. 4, pp. 48-59. https://doi.org/10.1108/03074350210767825