Analysis of P/E ratios and interest rates

Abstract

1995),"Forecasting sales, expenses and stock market values by quarterly financial statement ratio analysis: a microcomputer software development model"If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service information about how to choose which publication to write for and submission guidelines are available for all. Please visit www.emeraldinsight.com/authors for more information. About Emerald www.emeraldinsight.comEmerald is a global publisher linking research and practice to the benefit of society. The company manages a portfolio of more than 290 journals and over 2,350 books and book series volumes, as well as providing an extensive range of online products and additional customer resources and services.Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of the Committee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive preservation. AbstractThis study analyses the relationship between P/E ratios and interest rates from early 1965 to the end of 1997. Historical Canadian data indicate that the average P/E ratio of the TSE 300 Index which was 17.17 in the 1960s and early 1970s decreased to about 8.92 in the periods of high interest rates in the late 1970s and early 1980s. However, in the late 1980s and 1990s the average P/E ratio increased to the previous levels of 17.20 when interest rates were on the decline. A similar pattern was observed for the various industry P/E ratios. The latest period is characterized by higher volatility compared to the previous periods. The correlations between P/Es and interest rates were negative and very high, confirming the inverse relationship between P/E ratios and interest rates. A regression analysis also indicates that interest rates are inversely related to P/E ratios after controlling for other relevant factors. This study, therefore, suggests that the low levels of interest rates, increased dividend payout, low corporate bond risk premium, and higher corporate earnings are the major factors which propelled equity values to their previous high levels.