Return predictability and valuation ratios: sector-level evidence on the Johannesburg stock exchange

Abstract

The efficient market hypothesis describes an efficient market as one in which investors cannot consistently predict stock returns because prices instantly reflect all the information flowing into the market. However, return predictability has been documented in many markets. This study tests the predictability of returns using two valuation ratios-the dividend and earnings yields-on the South African market, at both aggregated and sectoral level. Unlike most studies in South Africa, this study employs an apposite present value model, accounts for structural breaks and investigates the non-linearity of the relationship between stock returns and valuation ratios. The results show that returns are predictable at both aggregated and sectoral levels. This finding has implications for market efficiency through enhanced price discovery which, in turn, has implications for investment and portfolio management. However, it should be noted that statistical significance may not ABOUT THE AUTHORS Kudakwashe Joshua Chipunza is a former postgraduate student at the University of KwaZulu-Natal in the School of Accounting, Economics and Finance. His research interests include financial markets, financial inclusion and development finance.Hilary Tinotenda Muguto is a PhD candidate at the University of KwaZulu-Natal under the HEARD division. His research interests include healthcare equity and finance, financial markets, behavioural finance, investment analysis and development economics.

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