The aim was to develop a composite outcome indicator to identify infants with severe adverse outcomes in routinely collected population health datasets, and assess the indicator's association with readmission and infant mortality rates. A comprehensive list of diagnoses and procedures indicative of serious neonatal morbidity was compiled based on literature review, validation studies and expert consultation. Relevant diagnoses and procedures indicative of severe morbidity that are reliably reported were analysed and reviewed, and the neonatal adverse outcome indicator (NAOI) was refined. Data were obtained from linked birth and hospital data for 516,843 liveborn infants ≥24 weeks gestation, in New South Wales, Australia from 2001 to 2006. Face validity of the indicator was examined by calculating the relative risks (and 95% CI) of hospital readmission or death in the first year of life of those infants identified by the NAOI. Overall 4.6% of all infants had one or more conditions included in the NAOI; 35.4% of preterm infants and 2.4% of term infants. Infants identified by the composite indicator were 10 times more likely to die in the first year of life and twice as likely to be readmitted to hospital in the first year of life compared to infants not identified by the NAOI. The NAOI can reliably identify infants with a severe adverse neonatal outcome and can be used to monitor trends, assess obstetric and neonatal interventions and the quality of perinatal care in a uniform and cost-effective way.