The Change in the Stock Price Based on the Information Resulting from the Financial Ratios
Evidence from Palestine Stock Exchange
Master's Thesis 2015 73 Pages
Table of Contents
A Holy Qur'an Verse
List of tables
List of Abbreviations
The Study Background
1.2 The study Problem
1.3 The study Importance
1.4 The study Objectives
1.5 The study hypothesis
1.6 The study Variables
1.6.1 Dependent Variable
1.6.2 Independent Variables
1.7 The literature Reviews
Financial Analysis Stock Valuations
2.2 Financial Analysis
2.3 The important of financial analysis:
2.4 Financial Ratio Analysis:
2.5 The types of financial ratio:
2.5.1 Liquidity Ratios:
2.5.2 Activity ratios:
2.5.3 Debt Ratios:
2.5.4 Profitability Ratios:
2.5.5 Market ratios:
2.6 Potential problems and limitations of financial ratio analysis:
2.7 Stock valuation:
2.7.1 Dividend Yield:
2.7.2 Capital Gains Yield:
2.7.3 Total Return:
2.9 Computing Stock Value:
2.9.1 Constant Growth dividends:
2.9.2 Non-constant Growth Stock dividends:
2.9.3 Zero growth dividends:
The Study Methodology Data analysis
3.1 The Study Methodology
3.1.2 The study Design
3.1.3 The Study Population
3.1.4 The Study Sample
3.1.5 The Data Collection
220.127.116.11 The Secondary Data
3.1.6 Data Analysis
18.104.22.168 Collection steps for analysis
3.2 Data analysis Test the hypothesis
3.2.2 Statistical analysis Test hypothesis
22.214.171.124 Industry sector
126.96.36.199 Investment sector
188.8.131.52 Service sector
184.108.40.206 Insurance sector
220.127.116.11 Banking sector
The Results Recommendations
4.1 The results
4.2 The recommendations
4.3 Future study
This study aimed to predict stock prices in Palestine Stock Exchange (PEX) by testing group of financial ratios and find a quantitative model, in which can be relied upon to predict the stock price for each sector. This model will help investors make rational decisions when they make investment decision in the financial market. To achieve this purpose, (17) financial ratios from (35) listed companies were tested using the available data for period 2009-2013.
These ratios were analyzed using multiple regression to find the best model for each sector of (PEX). Several financial ratios can be used to predict the stock price in the industry sector, which are (earning per stock, market price on book value, days sales outstanding, fixed assets turnover, return on equity and profit margin). In the investment sector, the following ratios (market price on book value, assets turnover, market price on cash flow and fixed assets turnover) can be used to predict the stock price. Adding to that, the ratios of (earning per stock, market price on book value and return on equity) can predict the stock price of service sector. In the insurance sector, the ratios of (earning per stock, return on assets, debt ratio and assets turnover) can be used in predicting stock price. Finally, the ratios of (market price on book value, earning per stock, return on equity, basic earning power and fixed assets turnover) predicting the banking sector stock price.
The study recommended the need to increase attention and caring when preparing the financial statements and must be prepared according to the Palestinian Stock Exchange standards, and the investors can rely on financial analysis of the financial statements when making financial investment decisions.
To my Parent, who scarify for our benefits, and make us what we are now.
To my Brothers and Sister, who we grew together.
To my Professors and Lecturers, who gave me their knowledge and experience. To my Friends, who support me all the time.
To my Lovely country PALESTINE.
To my Fellow student, who will together build the country.
To our Palestinian martyrs, who scarify themselves for holy land.
First and above all, I praise God, the almighty for providing me this opportunity and granting me the capability to proceed successfully. This study appears in its current form due to the assistance and guidance of several people. I would therefore like to offer my sincere thanks to all of them.
I would like to express my sincere gratitude to my supervisor Prof. Faris Abu- Moumer for the continuous support of my study, for his patience, motivation, enthusiasm, and immense knowledge. His guidance helped me in all the time of research and writing of this study. I could not have imagined having a better supervisor and mentor for my study.
Besides my supervisor, I would like to thank the rest of my study committee: Prof. Salem Helles and Prof. Yousif Ashour for their encouragement, insightful comments, and hard questions.
Finally, thanks my family for the support they provided me through my entire life and in particular, I must acknowledge all my friends, without whose love, encouragement and editing assistance, I would not have finished this study.
List of tables
Table (1): Summary of the Literature Review 12
Table (2): Summery of the current study 15
Table (3): Describe the study population and sample 28
Table (4): Describe the financial ratios that used and its equation 29
Table (5): Describe the correlation between the dependent variable and independent variables in industry sector 31
Table (6): STEPWISE Regression Results of Industry sector 34
Table (7): Describe the correlation between the dependent variable and independent variables in investment sector 36
Table (8): STEPWISE Regression Results of Investment sector 39
Table (9): Describe the correlation between the dependent variable and independent variables in service sector 41
Table (10): STEPWISE Regression Results of Service sector 44
Table (11): Describe the correlation between the dependent variable and independent variables in insurance sector 45
Table (12): STEPWISE Regression Results of Insurance sector 49
Table (13): Describe the correlation between the dependent variable and independent variables in banking sector 50
Table (14): STEPWISE Regression Results of banking sector 54
List of Abbreviations
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Chapter 1 The Study Background
In modern economy a variety of tools have been established to cope with the development of this economy, the financial markets are clear example of this tools as it works as a mechanism of deploying money in the form of stocks and bonds and other financial instruments to collect preferably a considerable return, this happens by going to guaranteed investment and risky ones in a parallel lines so the expectations and desires of the investors are met, the determinant of how healthy is this investment is the figure you see on the screen at the time of sale known widely as the price of stock, whenever it’s higher than the purchase price it proves that a sound investing decision has been made (Hunjra et al, 2014 ).
Stock price is not a sole indicator for decision makers, otherwise a careful planning process takes place by what is called financial analysis, a plenty of definitions have been set to describe this important term and one of these agreed upon definitions the one that define it as "processing of financial data available on the institution in order to obtain such information used in making decisions and in evaluating the performance of business and industry in the past and the present as well as in the diagnosis of any problem exists, financial or operational and anticipate what will be the situation in the future" (Al-Qudah, 2013). One technique for financial analysis is to calculate financial ratios which have a predetermined formula and then interpret the results to obtain an overview of the firm position and decide on a logical investment strategy.
However, the financial ratios (liquidity, activity, debt, profitability and market) still kept its classical and fundamental power either as part of these financial and accounting models or as another important supportive analysis with it. Because of the proven power of the ratio analysis in the practical financial and planning analysis, this study will investigates the relationship between financial ratios and stock price by using five categories of commonly used financial ratios including Liquidity, Activity, Debt, Profitability and Market ratios.
The Palestine Exchange (PEX) was established in 1995 to promote investment in Palestine as a private stockholding company and transformed into a public stockholding company in February 2010 responding to principles of transparency and good governance. The PEX was fully automated upon establishment- the first fully-automated stock exchange in the Arab world and the only Arab exchange that is publicly traded and fully owned by the private sector. The PEX operates under the supervision of the Palestinian Capital Market Authority. There are 49 listed companies as of 16/11/2014 with market capitalization of about $3.088 billion across five main economic sectors; banking and financial services, insurance, investments, industry, and services. Most of the listed companies are profitable and trade in Jordanian Dinar, while others trade in US Dollars.
1.2 The study Problem
Companies’ investors don’t rely on the financial ratios (liquidity, activity, debt, profitability and market) when they invest or think to invest on them, and (67.08%) of investors in the financial market affected by rumors during trading to make investment decisions, so the investment decisions are risky, that requires the provision of confidence in the financial information contained in the financial reports (Alnamrouti Alaoise, 2012) (Shahen, 2007). The problem can be formulated as the follow:
What is the role of information resulting from the analysis of financial ratios on
the change in stock prices?
What is the role of Liquidity ratios on the change in stock prices?
What is the role of Activity ratios on the change in stock prices?
What is the role of Debt ratios on the change in stock prices?
What is the role of Profitability ratios on the change in stock prices?
What is the role of Market ratios on the change in stock prices?
1.3 The study Importance
The importance of this study is looking at the process of financial analysis for companies that are trading their stocks in the financial market and because the activity the financial market in any country reflects the economic activity in it, so there are economic and political factors affect the behavior of investors, and the performance of the financial market, so the study comes to confirm the importance of financial analysis and its role in predicting stock prices.
1.4 The study Objectives
The study aimed to:
To identify the dimensions of the financial analysis and its importance in predicting stock price of the Palestine Exchange sectors.
The formulation of the intellectual aspects of financial analysis and use it to develop the concept and standards to change and predict stock prices of the Palestine Exchange sectors.
To prepare a quantitative model that can be relied upon to determine the stock price of each sector of the Palestine Exchange sectors.
1.5 The study hypothesis
- There is a significant relationship between the Liquidity ratios and stock price of the listed companies in Palestine Stock Exchange.
- There is a significant relationship between the Activity ratios and stock price of the listed companies in Palestine Stock Exchange.
- There is a significant relationship between the Debt ratios and stock price of the listed companies in Palestine Stock Exchange.
- There is a significant relationship between the Profitability ratios and stock price of the listed companies in Palestine Stock Exchange.
- There is a significant relationship between the Market ratios and stock price of the listed companies in Palestine Stock Exchange.
1.6 The study Variables
1.6.1 Dependent Variable: is the stock price of the companies listed in Palestine Stock Exchange.
1.6.2 Independent Variables: the financial ratios of the companies listed in Palestine Stock Exchange to measure their contribution in stock price.
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Figure No (1)
1.7 The literature Reviews
Al-Qudah (2013), Study: The Importance of Financial Analysis for Published Financial Information to Predict the Stocks Behavior (Case study-ASE -Industrial Sector Jordan)
This study aimed to identify the dimensions of the financial analysis and its advantages and how to benefit from it; in predicting stock prices by testing group of financial ratios and find a model quantitatively can be relied upon to predict the price per stock of the industrial sector in the Amman Stock Exchange in order to help investors make rational decisions. To achieve this purpose three financial ratios has been tested for a sample of 30 companies. These ratios have been analyzed using the multiple regression to find the best model for the industrial sector of the financial market. The results of the study that the industry sector was affected by several variables affect the stock price of this sector are (market value to book value, earning per share and the market price to earnings per share). The study recommended increased attention to the financial statements and transparency in the preparation and disclosure of the data and prepared according to international accounting standards, and it can an investor rely on financial analysis of the financial statements when making investment decisions.
Karami and Talaeei (2013), Study: The Predictability of stock returns using financial ratios in the companies listed in Tehran Stock Exchange
The study aimed to assess correlation between financial ratios and their impact on predicting stock returns for the companies listed in the Tehran Stock Exchange covers four financial ratios including price to earnings, book to market value, dividend yield, and capital gain. In order to test the hypotheses, the historical data over a ten year period during 1998-2007 for the sample (66 companies) under study were extracted from the respective data bases. The study used E-views Software as well as simple and multiple linear regression in data analysis book value to market value and capital gain significantly affect stock return predictability and that stock return can be predicted by analyzing these variables. The study recommended that there is an effective relationship between the ratio of price to earnings and the ratio of book value to market value of the stock returns, the stockholders are recommended to pay close attention to these ratios when forming their portfolios.
Pourkand and Babayazar (2013), Study: The Relation between Stocks Returns and Financial Ratios Changes
The aim of this investigation is examination relationship between financial ratios changes and stock returns changes in accepted companies in stock security exchange of Tehran. The statistical community of this investigation are accepted company in stock market of Tehran and the statistical sample is consist of 53 active company of different industries during 2007 until 2011. Hypothesis are experimented by Smirnoff - Calmogorof tests, independent and parsons cohesiveness. The study used the regression model in analysis. The results of the study that there is significant and weak cohesiveness between cash ratios changes (current and quick ratios) and profitability ratios changes (grass profit/sales and profit/sales) with stock output in stock exchange. And indicated that other important factors can make an effect stock returns, such factors are economics status of commercial unites, type of industry, inflation price and the effect of other stimulus in stock returns of Iranian company such as rumor, political affairs and pricing less than fact stock in first supply to public.
Placido and Menaje (2012), Study: The Impact of Selected Financial Variables on Stock Price of Publicly Listed Firms in the Philippines
This study aimed to determine whether earnings per stock (EPS) and return on assets (ROA) have significant influence on stock price of publicly listed firms in the Philippines. Using the 0.05 level of significance, the study tested whether or not EPS and ROA have significant impact on the stock price of 50 publicly listed firms in the Philippines for the year 2009 with the null hypothesis that EPS and ROA have no significant impact on stock price. Result of the Spearman Rank order Correlation disclosed strong positive correlation of EPS with stock price. ROA disclosed a weak negative correlation with stock price. Multiple regression results showed that the chosen model was able to explain 73% of the average change in stock price. The study recommend the continued use of EPS as a predictor of share price, Future researches on this topic should cover a longer period and greater number of respondents if the researcher intends to use panel or pooled data.
Kabajeh, AL Nu’aimat and Dahmash (2012), Study: The Relationship between the ROA, ROE and ROI Ratios with Jordanian Insurance Public Companies Market Share Prices
The purpose of this study is to examine the relationship between the ROA, ROE and ROI ratios together and separately with Jordanian insurance public companies stock prices. The population of this study consisted of all the Jordanian insurance public companies listed in Amman Security Exchange from the period between 2002 and 2007 which were (28) public companies. Based on the empirical evidence, the results showed a
positive relationship between the ROA, ROE and ROI ratios together with Jordanian insurance public companies stock prices. The results also showed a positive but low relationship between each of ROA ratio separately and ROI ratio separately with Jordanian insurance public companies stock prices. However, the results showed no relationship between the ROE ratio separately with Jordanian insurance public companies market stock prices.
Kohansal et al. (2012), Study: The Relationship between Financial Ratios and Stock Prices for the Food Industry Firms in Stock Exchange of Iran
The main subject of the relationship between financial ratios and stock prices of companies listed on the Stock Exchange of food. The data from the years 1992 to 2010 were used to stock the food of choice for companies. Financial variables including liquidity ratios (current ratio), the ratio of activity (asset turnover), the profitability (rate of return on assets and return on equity) and financial leverage (debt) and equity prices food stock. Some results indicate that there is a positive and significant response in food prices due to stocks of the current ratio, return on assets and return on equity rate. The results of this analysis also show that in the first period of greatest change in the current ratio is explained by this variable. But this stock has been declining gradually. Variance of decomposition of the asset turnover ratio fluctuations in their asset turnover ratio on the performance. Analysis of financial leverage financial leverage on the shock of their impact is an important variable. As was shown, during this period of the shock on their first reaction is positive and significant but fluctuating after that.
Khan (2012), Study: The Effect of Dividends on Stock Prices- A Case of Chemical and Pharmaceutical Industry of Pakistan.
This study will help to ameliorate dividend decisions of corporate sector through felicitously appropriate implementation of their dividend policies. This paper is an attempt to explicate the affect of dividend announcements on stock prices of chemical and pharmaceutical industry of Pakistan. A sample of twenty nine companies listed at KSE-100 Index is taken from the period of 2001 to 2010. Results of this study is predicated on Fixed and Random Effect Model which is applied on Panel data to explicate the relationship between dividends and stock prices after controlling the variables like Earnings per Stock, Profit after Tax and Return on Equity. The Results show that Stock Dividend, Earnings per Stock and Profit after Tax have a significant positive relation to stock market prices and significantly explicates the variations in the stock prices of chemical and pharmaceutical sector of Pakistan while Retention Ratio and Return on Equity have the negative insignificant relation with stock prices. This paper further shows that Dividend Irrelevance Theory is not applicable in case of chemical and pharmaceutical industry of Pakistan.
Abu Mouamer (2011), Study: The determinants of capital structure of Palestine listed companies.
The purpose of this paper is to examine the relationship between capital structure and debt lifetime among listed companies in Palestine stock market. Only 15 firms working in different economic sectors qualified to be included in the study sample according to the availability and continuity of published financial statements during the period of 20002004. Variables used for the analysis include profitability, leverage ratios total debt (TD), short-term debt (STD) and long-term debt (LTD)), liquidity (LQ), age, asset structure, and firm size and sales growth are also included as control variables. The panel character of the data allows for the use of panel data methodology. The study has shown that the service companies have the highest TD ratio (53.69 percent), followed by industrial companies (50.86 percent), trade companies (34.11 percent) and agriculture companies (24.02 percent). The one way analysis of variance (ANOVA) shows no significant difference in the use of debt, neither total, LTD or STD among companies in the four sectors. The correlation analysis has shown that TD is positively and significantly related to TAN, on the country, no significant relationship between the long debt and STD on the one hand and age, growth, LQ, TAN, and size on the other hand.
Ibrahim, Kheradyar Nor (2011), Study: The Stock Return Predictability with Financial Ratios.
This study aimed to examine whether financial ratios can predict stock returns. This study comprised a period of 10 years, starting from January 2000 to December 2009, and the units of analysis include 960 companies at the end of 2009 that are listed on Malaysia stock exchange (Bursa Malaysia). The study select three financial ratios include dividend yield, earning yield and book-to-market ratio (B/M) that have been documented to predict stock returns. This study applies generalized least squares techniques to estimate the predictive regressions in form of simple and multiple models of panel data sets. The obtained results reveal that the financial ratios can predict stock return, as the B/M has the higher predictive power than DY and EY respectively. Furthermore, the financial ratios are able to enhance stock return predictability when the ratios are combined in the multiple predictive regression models.
Taani and Banykhaled (2011), Study: The Effect of Financial Ratios, Firm Size and Cash Flows from Operating Activities on Earnings per Share: (an Applied Study: on Jordanian Industrial Sector)
The aim of this study is to examine the effect of accounting information on earning per stock (EPS) by using five categories of financial ratios. A sample of 40 companies listed in the Amman Stock Market was selected. To measure the impact of financial ratios on EPS multiple regression method and stepwise regression models are used by taking profitability, liquidity, debit to equity, market ratio, size which is derived from firm’s total assets, and cash flow from operation activities as independent variables ,and EPS (Earning Per Stock) as dependent variable. The results showed that the profitability ratio (ROE), Market ratio (PBV), cash flow from operation/sales, and leverage ratio (DER) has significant impact on earnings per stock. This research also exposes that the movement of earning per share is affected much by factors other than firm's financial performance. From all models used in this research, the highest R2 is only 42%.
Aono and Iwaisako,T (2010), Study: The Forecasting Japanese Stock Returns with Financial Ratios and Other Variables
This paper extends the previous analyses of the forecast ability of Japanese stock market returns in two directions. First, the study carefully construct smoothed market price-earnings ratios and examine their predictive ability. The study find that the empirical performance of the price-earnings ratio in forecasting stock returns in Japan is generally weaker than both the price-earnings ratio in comparable US studies and the price dividend ratio. Second, also it examined the performance of several other forecasting variables, including lagged stock returns and interest rates. The study find that both variables are useful in predicting aggregate stock returns when using Japanese data. However, while the study find that the interest rate variable is useful in early subsamples in this regard, it loses its predictive ability in more recent subsamples. This is because of the extremely limited variability in interest rates associated with operation of the Bank of Japanese zero interest policy since the late 1990s. In contrast, the importance of lagged returns increases in subsamples starting from the 2000s. Overall, a combination of logged price dividend ratios, lagged stock returns, and interest rates yield the most stable performance when forecasting Japanese stock market returns.
Roux (2010), Study: The Investigating the relationship between the Price- Earnings ratio and future stock returns in the South African market
This study replicates the statistical study conducted by Vivek Bhargava and D. K. Malhotra to determine whether P/E ratios drive future stock earnings or drive future stock prices on various international markets. Statistical analysis is conducted on indices on the South African market, in order to determine if P/E ratios drive subsequent closing prices or closing prices adjusted for total return. The study is extended by constructing two trading models, to practically test the possible benefits of using the P/E ratio value as a predicting and trading measure in the South African market. Although Johansen cointegration tests reveal that co-integration relationships exist between the P/E ratio and subsequent closing prices and adjusted closing prices for total return, the VAR and VECM models used to estimate these relations do not yield significant results. Granger causality tests show very weak causal relation between the P/E ratio values and future closing prices and closing prices adjusted for total return.
Martani, Mulyono and Khairurizka (2009), Study: the effect of financial ratios, firm size, and cash flow from operating activities in the interim report to the stock return.
The aim of this study is to examine the value relevance of accounting information in explaining stock return. The study uses profitability, liquidity, leverage, market ratio, size and cash flow as proxies of accounting information. Cumulative abnormal return and market adjusted return are used as stock return variables. The samples of the study are listed companies in manufacturing industries that actively trading between (2003-2006) in Indonesia Stock Market. The study finds that profitability (net profit margin), assets turnover and market ratio (book value to market price) has significant impact to the stock return. It shows that from investors’ point of view financial ratios are useful in making decision on investment. This research also exposes that the movement of stock price is affected much by factors other than firm’s financial performance.
Al Gergawi (2008), Study: The role of financial analysis of financial information published in the financial statements to predict the prices of shares: applied study on the companies listed on the Palestine Securities Exchange.
This study aimed to identify the dimensions of financial analysis, its characteristics and how to benefit from it in predicting stock prices through test a set of financial ratios for each sector in the Palestinian securities exchange market. The sample of study included 10 companies (2 companies from each sector). These ratios were analyzed using statistical technique known as multiple regressions to reach the best model for each segment of the market. The results of this study that there is many variables that have a significant relationship with market price. In the insurance sector (ROA, ROE, EPR P/B), in the banking sector (P/B P/EPR), in the investment sector (current ratio, ROA, RPE, EPR and P/B), in the service sector (ROA, ROE, profit margin, fixed assets turnover, EPR and P/B) and in the industry sector (current ratio, ROA, ROE, profit margin, fixed assets turnover and P/B). This study recommended that it could rely on a set of financial ratios for each sector to predict the stock price.
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The main differences between the previous studied and current study
The current study was used (17) financial ratios. While the previous studies between were used (1-12) financial ratio.
The current study used many financial ratios (Inventory turnover, Days sales outstanding, time interest earning and price/cash flow), but all previous studies didn’t used it.
The current study applied the ratios on all companies listed in (PEX) that have available data.
The study of Al Gergawi implemented in PEX between (1996-2006). While the current study implemented in the period of (2009 - 2013), taking in to considerations that there were many events occurred in this period.
The current study was benefited from previous studies in the construction of theoretical and practical framework.