The price-earnings ratio and the equity returns in India

The study examines the empirical relationship between the price-earnings ratio and subsequent equity returns in Indian capital market. The relationship between the two variables of 80 companies listed in Bombay Stock Exchange, comprising equally of both traditional and contemporary industries is studied over a period of eight years spanning from 2001 to 2008. Rather than a single holding period the study considers multiple holding period of different time durations ranging between six months to four years. The results reveal that the price-earnings ratio and subsequent equity returns are inversely related and the relationship is stronger in case of traditional industries. The study also finds that the inverse-relationship between the price-earnings ratio and subsequent equity returns grows stronger as the holding period duration increases. While the variability of equity returns is explained to a good extent by the linear relationship between the price-earnings ratio and equity returns, the role of other factors cannot be ignored. The study further identifies that variability of equity return is explained to greater extent by the linear relationship between the price-earnings ratio and equity returns, during longer holding periods (two to four years) and for the traditional industries.