CAN DIVIDEND YIELD AND P/E RATIO PREDICT EQUITY PREMIUM? EVIDENCE FROM THE MALAYSIAN MARKET

The purpose of this study is to identify whether the dividend yield and price- earnings ratio (P/E) have significant explanatory power to predict the stock returns from the Malaysian market perspective. Additional analysis was carried out to determine which of these two independent variables has more effect in predicting the stock returns measured by the equity premium stock i.e. returns on stock market minus the returns on short-term risk-free treasury bills (Rmt - Rft). This study covers a period from 1973 to 2005, which consists of all listed companies on Bursa Malaysia (formerly known as Kuala Lumpur Stock Exchange, KLSE). The result shows that price-earnings ratio has more predictive power than dividend yield. For the robustness test, the full sample period was divided into two sub-samples i.e. 1973 - 1988 and 1989 - 2005. The result was consistent with some other literatures that P/E is more significant to predict the future stock returns than dividend yield even though the explanatory power is very low. Dividend yield is significant for both subperiods as compared to the full sample period. It shows that the results are robust for dividend yield.