P/E Ratio and the Dividend Yield as Forecasting Tools in the Istanbul Stock Exchange

We investigate the ability of average price-earnings (P/E) ratio and dividend yield as predictors of future returns at the Istanbul Stock Exchange during the 10-year period between 1986-1995. We examine the returns on the ISE Composite Index followed by periods of P/E ratio and dividend yield quintiles ranging from low to high. We find that 3-month, 6-month and 12-month returns following periods of low P/E ratios and high dividend yields are significantly higher than those after periods of high P/E ratio and low dividend yields. In terms of real returns, low P/E ratio and high dividend yields are followed by positive returns over all horizons, whereas real returns are negative subsequent to periods with high P/E ratio and low dividend yield. A market timing strategy based on switching between bonds and stocks according to the level of P/E ratios and dividend yield is tested. We find that the performances of those portfolios are superior to controlled portfolios that are divided between bonds and stocks.