Macroeconomic Variables and the E/P Ratio
32 Pages Posted: 21 Dec 2001
Date Written: December 15, 2001
Although the price-to-earnings ratio and, its inverse, the earnings-to-price ratio (E/P) are frequently used by academics and practitioners, very little is known about their association with macroeconomic variables over the long term. In this paper, we examine the annual E/P ratio at the economy level for a 49-year period starting from 1952 until 2000. We also present results of associations between the E/P ratio and real interest rate, expected growth in real GDP, index of consumer sentiment and two proxies for economy-wide risks. Our study is also motivated by a previous surprising finding that the E/P ratio is positively correlated with inflation. Our data cover a longer time period than previous studies. We divide the time period into three subperiods roughly representing different underlying regulatory and economic environments. We find that the results across the three sub-periods are not consistent with one another: The association between expected (or realized) inflation and the E/P ratio is significantly negative in the first subperiod and significantly positive in the third subperiod. We conclude that the observed association between the earnings-to-price ratio and inflation may be spurious.
Keywords: P/E ratio
JEL Classification: G12, M4
Suggested Citation: Suggested Citation