An empirical analysis of the relationship between market multiples and share returns using South African data

Abstract

For many years, there has been an attempt to change the study of economic environment to pure science, and even if this has been elusive, significant effort has been made. The aim is to understand and predict economic environments for decision-making that enables successful investment. One such phenomenon has been the development of metrics such as multiples to understand the health of businesses. This study seeks to investigate the nexus between price multiples and share returns using South African data. A sample is obtained from the Top 40 Johannesburg Stock Exchange (JSE) - listed companies for the period from 2010 to 2021. These data are then analysed through regression analysis to establish the strength as well as the direction of the relationship. The study established a negative relationship between Price-to-Earnings (P/E) and Price-to-Sales (P/S) ratios with share returns while a positive relationship was found with Price-to-Book (P/B), Price-to-Cash Flow (P/CF) and Price-to-Earnings Before Interest, Taxes , Depreciation and Amortisation (P/EBITDA) ratios. The results obtained provide an impetus for further studies to incrementally develop finance theory for the betterment of successful investment decisions in emerging markets in general and South Africa in particular. South Africa is the biggest investment destination in Africa but there is a paucity of information on how the market multiples relate to share returns, which relationship has helped investor decision-makers in developed as well as some emerging markets in Asia.