Fundamental determinants of the Australian price–earnings multiple Abul F.M. Shamsuddin a, * , John R. Hillier b a Newcastle Graduate School of Business, University of Newcastle, Callaghan, NSW 2308, Australia b Deakin Business School, Deakin University, Malvern, Victoria 3144, Australia Received 23 October 2002; accepted 9 February 2004 Available online 4 July 2004 Abstract This paper is the first attempt to investigate the factors fundamental to the setting of the price – earnings (P – E) multiple for the Australian stock market. The quarterly P – E ratio for the ASX 200 index is used as a measure of the market wide P – E multiple. It is demonstrated that a large portion of the variation in the P – E multiple can be explained by the dividend payout ratio, interest rates and GDP growth rates. In addition, consumers’ confidence—a leading indicator of future growth opportunities, the Australian – US exchange rate—a key determinant of the competitiveness of domestic companies, and volatility of domestic market returns—a risk factor, have incremental explanatory power. The results are compatible with market rationality and they suggest that unlike the US, the actual time path of the Australian P – E multiple is primarily driven by the indicated fundamentals. D 2004 Elsevier B.V. All rights reserved. JEL classification: C51; E44; G12 Keywords: Price – earnings ratio; Dividend discount model; ASX 200 Index; Prediction accuracy 1. Introduction The price–earnings (P–E) multiple is a widely used measure of relative equity valuation. Individual stocks, and the collections of stocks reflected by market indices such as those provided by the Australian Stock Exchange (ASX), are typically evaluated 0927-538X/$ - see front matter D 2004 Elsevier B.V. All rights reserved. doi:10.1016/j.pacfin.2004.02.001 * Corresponding author. Tel.: +61-2-4921-8971; fax: +61-2-4921-7398. E-mail address: Abul.Shamsuddin@newcastle.edu.au (A.F.M. Shamsuddin). www.elsevier.com/locate/econbase Pacific-Basin Finance Journal 12 (2004) 565 – 576