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IMPACT OF MARKET-BASED RATIOS ON STOCK RETURNS

ABSTRACT

         “Market-based” ratio analysis is a specialty in accounting that x-rays the situation and the financial performance of a company. They help to set standard of various industries. This study is aimed at evaluating the impact of market based ratios on stock return using six banks. The data used for this research work are secondary data obtained from the Nigeria stock exchange stock price book/annual report from 1993 to 2013. Panel data regression analysis (serial correlation and heteroskedasticy model) was used. Findings revealed that Earnings per share has significant impact on stock returns while Price –earnings ratio and Dividend yield have a positive relationship with are stock returns of firms though they are not significant with regard to this research work. This is in line with Capital Asset Pricing Model and Modern Portfolio Theory. It was concluded that market based ratios have impact on stock returns and therefore recommended that managers, investors and financial analyst to take market based ratios analysis important for better economic development of the nation.

 

CHAPTER ONE

1.0   INTRODUCTION

1.1   BACKGROUND OF THE STUDY

Shares and stock of companies have over time been seen as a parameter for appraising the performance of public limited liability companies the world over. In the view of Okpara (2010), a company’s health is measured by fluctuations in its share prices. This, nonetheless acknowledges changes in economic conclusions, profile ratings and company customers demand. In this regard, stock market returns, according to Osiegbu (2005) is the central focus of capital market activities in rallying point of finance analyst and stock brokers.

Economic growth has been described in economics as the desired state of any progressive nation. According to Ihendinihu and Onwuchekwa (2012), economic growth in a modern economy hinges on an efficient and effective financial sector that pools domestic savings and mobilizes productive investments; productive projects may remain redundant where absence of an efficient set of financial institutions exists. Investment that promotes economic growth and development requires medium and long term funding which is far longer than the duration for most savers willing to their funds. The inability of the banking sector, a major player in the money market to issue long term fund for economic development has created a need for a better and more efficient market that serve as a medium where long term capital can be mobilized to finance development projects/programmes of government and corporate bodies.

According to Atoyebi et al (2013) capital market has been broadly defined as an institution where medium and long term finance can be raised. It can also be viewed as a network of specialized financial institution series of mechanism, process and infrastructure that facilitates the contact between suppliers and users of medium to long term capital for investment in the economy. It has been argued that most Nigeria businesses lack long term capital. Hence the business sector in Nigeria has been relying on short term financing such as overdrafts to finance even long term capital. Based on the maturity marching concept in such financing becomes risky. The implication of the above position, according to Adeniji (2010) asserted that stock market affects economic activity through the creation of liquidity. It contributes to economic development by enhancing the creation of liquidity of capital investments. Many profitable investments require a long term commencement of capital but investors are often reluctant to relinquish control of their savings for long periods. Liquid equity markets make investments less risky – and more attractive – because they allow savers to acquire an asset - equity – and to sell it quickly and cheaply if they need their savings or want to alter their portfolios. At the same time, companies enjoy permanent access to capital raised through equity issues. The Nigerian capital market needs to play the role of an enabler for the transformation of the Nigerian economy by becoming the first port of call for domestic savings and for international investors (Oleh, 2010).

The stock market is an investment roller coaster which rides on four wheels; market fundamentals, psychology, globalization and the macro-economy. Over the past decade, investors have found the Nigerian Stock Exchange a fertile ground to invest their fund. According to Oladipupo (2010), the Nigerian capital market of the pre-crisis period happened to be one of the most profitable investment havens in the economy. This is revealed in the consistent rise in the annual market capitalization of the Nigerian Stock Exchange (NSE) especially over the past decade, until the significant decline recorded after the market crash in 2008 in the aftermath of the global financial crisis. The liquidity that a stock exchange provides affords investors the ability to quickly and easily sell securities. This is an advantage of investing in stocks compared with other less liquid investments. People invest in stocks for an opportunity to make gains depending on the valuation (potential market prices). The value of a share is reflected in the price for which it sells in the market; hence the price may either encourage or discourage patronage (Sundayso, et al 2013).

Market based ratio analysis, in the opinion of Zeytinoglu (2012), is a widely used technique for evaluating the performance of a firm, there, however, exist some limitations in the use of ratios to this end, ratios must be applied with some degree of caution for the analysis of financial statement. Some of these limitations associated with ratio analysis include:

  1. It may be difficult for an outsider to carry out detailed ratio analysis because of limitation of information (in the annual report and accounts).
  2. Accounting information relates to a particular period and does not take account of cyclical structural variations in the environment.
  3. Ratios are calculated at a point and do not take cognizance of inflation or price changes in business accounting policies and government regulations and are therefore of limited value in predicting future results.

1.2 STATEMENT OF THE PROBLEM

(i)            Unavailability of complete stock market information relating to earnings per share overtime investors have been faced with situation of inadequately calculating earnings per share and this have made investment a great gamble. In cases where complete information exists, investment in public company becomes easy and less complicated.

(ii)         Decline in dividend yield, dividend per share of quoted entities in Nigeria: as a forerunner to the study, the researcher has observed a steady decline in Nigeria. This is further blamed on steady decrease in company’s profitability and a major concern to investors.

In view of the lingering challenges highlighted above, the researcher is motivated to carrying out studies of this nature to ascertain the impact of market based ratio on stock returns.

1.3 OBJECTIVE OF THE STUDY

The general objective of this research work is to determine the impact of market based ratio on stock returns. However, other specific objectives are to:

  1. Evaluate the relationship between earnings per share and stock returns
  2. Evaluate the relationship between price to earnings ratio and stock returns
  3. Evaluate the relationship between dividend yield and stock returns


1.4 RESEARCH QUESTIONS

The study seeks to answer the following key questions:

i)              What is the relationship between earnings per share and stock returns?

ii)           Does price to earnings ratio have any relationship with stock returns?

iii)         Is there any relationship between dividend yield and stock returns?

1.5 RESEARCH HYPOTHESIS

The following hypotheses are formulated for this study:

1)   H0: There is no significant relationship between earnings per share and stock returns.

H1: There is a significant relationship between earnings per share and stock returns

2)   H0: There is no significant relationship between price to earnings ratio and stock returns

H1: There is a significant relationship between price to earnings ratio and stock returns

3)   H0: There is no significant relationship between dividend yield and stock returns

H1: There is a significant relationship between dividend yield and stock returns

1.6 SCOPE OF THE STUDY

This study is aimed at discovering the impact of market based ratios on stock returns, and also by exposing the extent to which this market based ratios can affect investors. Market based ratios serve as an indicator for investment decision and market efficiency, to also uncover the relationship of these ratios on stock returns at the same time revealing whether it is a negative or positive impact. Accordingly, descriptive research design would be adopted for use, involving the collection of secondary data covering annual report and accounts of the following deposit money banks:

First Bank of Nigeria Plc,

Guaranty Trust Bank Plc

Wema Bank Plc

Union Bank Plc

UBA Bank Plc

The hire coverage for the research is 1993-2013 (21 years). Regression analysis would be employed in testing the three hypotheses using statistical package for social sciences. Findings derive will enable the researcher comparism with previous studies.

1.7 SIGNIFICANCE OF THE STUDY

It is felt that this study would be of immense benefits to a number of investors and firms in the following ways:

  • To create efficient market for potential investors and it is important indicator for investment decisions
  • To help investors know more about the effect market based ratios has on their investment
  • To help investors to decide the best market based ratios to use on their investment
  • Investors can be able to forecast the real value of stock by using this market based ratio

Government analyst, future researchers and the society in general can benefit from the information.

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