Economics and Finance 366514_a1d1_8
Dissertation: Cross Sectional Stock Returns and Fundamental Variables: Empirical Evidences from Kuala Lumpur Composite Index (Part 5/5)

CHAPTER 5: CONCLUSION

5.1     Review of Research Objective

In Chapter 1, it is explicitly outlined that this is a study to investigate if there are any statistically significant correlation relationships between cross sectional stock returns to several firm specific fundamental variables as follow: return on equity (ROE), price to earnings ratios (PE), price to sales ratio (PS), price to net worth ratio (PNet), dividend yield (DY), rate of growth in revenue (RG), payout ratio, rate of growth in earnings per shares (EPSG), and Price Earnings to Growth ratio (PEG), for companies listed under Kuala Lumpur Composite Index (KLCI) in Kuala Lumpur Stock Exchange (KLSE). In this section, the correlation relationships between cross sectional stock returns to the various fundamental variables will be summarized – as a way to answer and accomplish the research objective outlined earlier. A summary of the relationships between cross sectional stock returns to the various fundamental variables is presented in Table 5.1 as follow.

 

tabe5-1

 

5.2     Conclusions

In this dissertation, the different factors often incorporated by the practitioners, economists and scholars in explaining or predicting stock returns are reviewed. It is founds that successful investors tend to consider firm specific variables as influential factors in affecting stock returns. To explain, the successful investors emphasize on the consistency of earnings track records, profitability ratios, price multiples, debt to equity ratio, return on equity as well as growth in revenues for the long term. From the other hand, for the economists, macroeconomic variables that are perceived as influential and useful in estimating stock returns include interest rates, inflation rate, money supply, oil prices, exchange rates, unemployment rate and industrial production index. Lastly, it is argued that scholars tend to employ both the views of the successful investors as well as the economists in their studies.

A review of the existing literature found that there are some empirical evidences supporting the idea that certain macroeconomic variables are priced in explaining stock returns. However, the empirical evidences are mixed and not consistent. In certain studies, there are no statistically significant relationships found between stock returns and macroeconomic variables. However, the fundamental factors (i.e., those firm specific variables) are found to have better explanatory power. Among the fundamental factors that are found to be statistically significantly priced in explaining stock returns include the following: earnings, price multiple, profitability ratio, debt to equity, dividend related information as well as future cash flow.

In this dissertation, only those fundamental variables will be investigated, because it is found from literature review that fundamental factors tend to be more able to explain stock returns. Besides, this is a study on stock investment, which the objective is to understand on how to pick the high performance stock in the future. Thus, firm specific factors are more relevant in such a context – in explaining cross sectional stock returns in the financial market. In the contrary, macroeconomic forces is more likely to affect the stock market returns in a systematic manner. As such, the research objective is formulated as follow: to investigate if there are any statistically significant correlation relationships between cross sectional stock returns to several firm specific fundamental variables as follow: return on equity (ROE), price to earnings ratios (PE), price to sales ratio (PS), price to net worth ratio (PNet), dividend yield (DY), rate of growth in revenue (RG), payout ratio, rate of growth in earnings per shares (EPSG), and Price Earnings to Growth ratio (PEG), for companies listed under Kuala Lumpur Composite Index (KLCI) in Kuala Lumpur Stock Exchange (KLSE).

From the data analysis, this study conclude that the fundamental variables is useful in explaining cross sectional stock returns even in emerging country such as in Malaysia. For example, firms with high ROE tend to outperform those firms with lower ROE. Although evidences on such outperformance are not available in the other financial years, there are some periods that such outperformance may materialize. Then, dividend yields are found to be the most useful fundamental variables that can explain stock returns in the period under investigation. For example, in a research period of 5 years, dividend yield is positively and statistically significantly correlated to cross sectional stock returns in 3 of the financial years. Then, it is found that, among the many price multiples, namely, prices to earnings ratio, prices to sales ratios, and prices to net worth ratios are useful in explaining cross sectional stock returns in Malaysia.

There are several impacts from these results findings of this study, depending on the interpretation of the investors. Firstly, it is crucial that investors should study the fundamentals of the companies before investing. The market may not be as random as investors may perceive. Certain fundamental variables may be useful to identify better investing targets. Apart from that, in order to be successful in investing, the price is a crucial element to be aware of. Investors should never pay high prices for stocks, based on the fundamentals of the particular stock or company. The notion that – money is made in the buying, not in the selling – is supported. The price investors paid for the securities, will ultimately affect the returns of the investors. Last but not least, investors may seriously consider study and employ a combination of different fundamental factors in stock selection. This will likely to enhance their performance. To study the stock market is worthy efforts, as from a highly complex and dynamic financial market, there are evidences supporting that fundamental variables are correlated to stock returns. There are hopes for extraordinary or excess returns from the financial market.

5.3     Suggestions for Further Research

In this study, the relationships of cross sectional stock returns are investigated to different fundamental variables. However, these fundamental variables are not combined to explain cross sectional stock returns. It is highly likely that by combining the different fundamental variables, a better strategy to outperform the market can be elicited. As such in the future, investor may consider studying the profitability of stock investing strategies using a combination of influential fundamental variables in predicting or explaining stock returns.

Besides, it is acknowledged that certain fundamental variables are not investigated in this study. For example, these variables include, debt to equity ratio, return on capital and cash flow related variables. These variables are not studied due to limitation in resources and time constraints. As it is found that there are some empirical evidences supporting that the fundamental variables are useful in explaining stock returns, serious investors may consider studying these fundamental variables in predicting or explaining stock returns.

In this study, correlation coefficients are employed to study the relationships between fundamental variables and cross sectional stock returns. However, there are many other statistical methods to study the effectiveness or profitability from employing fundamental variables in explaining or predicting cross sectional stock returns. In the future, it is useful to adopt different strategies, methodologies or statistical tools in studying the relationships between fundamental variables and cross sectional stock returns.

REFERENCES

Ali, M., & Chowdhury, T. (2010). Effect of Dividend on Stock Price in Emerging Stock Market: A Study on the Listed Private Commercial Banks in DSE. International Journal of Economics and Finance, 2(4), 52-64.

Al-Tamimi, H., Alwan, A., & Rahman, A. (2011). Factors Affecting Stock Prices in the UAE Financial Markets. Journal of Transnational Management, 16(1), 3.

Bai, Y., & Green, C. (2011). Determinants of cross-sectional stock return variations in emerging markets. Empirical Economics, 41(1), 81-102.

Bai, Y., & Green, C. (2011). Determinants of cross-sectional stock return variations in emerging markets. Empirical Economics, 41(1), 81-102.

Bartens, R., & Hassan, S. (2010). Value, size and momentum portfolios in real time: the cross section of South African stocks. Australian Journal of Management, 35(2), 181-202.

Bodie, Z., Kane, A., & Marcus, A. J. (2007). Essentials of investments. New York: McGraw Hill.

Bondt, G. (2008). Determinants of Stock Prices: New International Evidence. Journal of Portfolio Management, 34(3), 81-92,8.

Bondt, G. (2008). Determinants of Stock Prices: New International Evidence. Journal of Portfolio Management, 34(3), 81-92,8.

Borys, M. (2011). Testing Multi-Factor Asset Pricing Models in the Visegrad Countries. Finance a Uver, 61(2), 118-139.

Brigham, E. F., & Houston, J. F. (2004).Fundamentals of financial management, 10th edition.Oxford: International Thompson Business Press.

Brzeszczynski, J., & Gajdka, J. (2007). Dividend-Driven Trading Strategies: Evidence from the Warsaw Stock Exchange. International Advances in Economic Research, 13(3), 285-300.

Buffett, M., & Clark, D. (2002). The new Buffettology: the proven techniques for investing successfully in changing markets that have made Warren Buffett the world’s most famous investor. London: Simon and Schuster UK Ltd.

Buffett, M., & Clark, D. (2008). Warren Buffett and the interpretation of financial statements: the search for the company with a durable competitive advantage. New York: Simon and Schuster Inc.

Campbell, K., & Ohuocha, C. (2011). The stock market reaction to stock dividends in Nigeria and their information content. Managerial Finance, 37(3), 295-311.

Campbell, J., Polk, C., & Vuolteenaho, T. (2010). Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns. The Review of Financial Studies, 23(1), 305.

Campello, M., & Chen, L. (2010). Are Financial Constraints Priced? Evidence from Firm Fundamentals and Stock Returns. Journal of Money, Credit, and Banking, 42(6), 1185.

Cao, Q., Parry, M., & Leggio, K. (2011). The three-factor model and artificial neural networks: predicting stock price movement in China. Annals of Operations Research, 185(1), 25-44.

Cavana, R. Y., Delahaye, B. L., and Sekaran, U. (2001), Applied Business Research: Qualitative and Quantitative Methods, Chichester: Wiley & Sons Ltd.

Chen, C., Lung, P., & Wang, F. (2009). Mispricing and the cross-section of stock returns. Review of Quantitative Finance and Accounting, 32(4), 317-349.

Cheng, M. T.  (2006). The Effect of Financial Ratios on Returns from Initial Public Offerings: An Application of Principal Components Analysis. International Journal of Management, 23(1), 187-194.

Clubb, C., & Naffi, M. (2007). The Usefulness of Book-to-Market and ROE Expectations for Explaining UK Stock Returns. Journal of Business Finance & Accounting, 34(1-2), 1.

Da, Z. (2009). Cash Flow, Consumption Risk, and the Cross-section of Stock Returns. The Journal of Finance, 64(2), 923.

Da, Z. (2009). Cash Flow, Consumption Risk, and the Cross-section of Stock Returns. The Journal of Finance, 64(2), 923.

De Peña, F., Forner, C., & López-Espinosa, G. (2010). Fundamentals and the Origin of Fama-French Factors: The Case of the Spanish Market*. Finance a Uver, 60(5), 426-446.

Domash, H. (2006). Fire your stock analyst: analyzing stocks on your own. New Jersey: FT Press.

Dorsey, P. (2004). The five rules for successful stock investing. New Jersey: John Wiley and Sons, Inc.

Dreman, D. (1998). Contrarian investment strategies: the next generation. New York: Simon & Schuster.

Edmans, A. (2011). Does the stock market fully value intangibles? Employee satisfaction and equity prices. Journal of Financial Economics, 101(3), 621.

Elder, A. (2002). Come into my trading room: a complete guide to trading. MA: John Wiley and Sons Inc.

Ellis, C. D. (2000). Winning the loser’s game: timeless strategies for successful investing. New York: Mc Graw Hill.

Fisher, K. L., Chou, J., & Hoffmans, L. (2007). The only three questions that count: investing by knowing what others don’t. New Jersey: John Wiley and Sons, Inc.

Florou, C., & Chalevas, C. (2010). Key accounting value drivers that affect stock returns: evidence from Greece. Managerial Finance, 36(11), 921-930.

Gogineni, S. (2010). Oil and the Stock Market: An Industry Level Analysis. The Financial Review, 45(4), 995.

Greenblatt, J. (2006). The little book that beats the market. New York: John Wiley & Sons, Inc.

Greenwald, B. C. N., Kahn, P., Sonkin, P. D., & Biema, M. V. (2001). Value investing: from Graham to Buffett and Beyond. New Jersey: John Wiley and Sons, Inc.

Jain, P. C. (2010). Buffett beyond value: why Warren Buffett looks to growth and management when investing. New Jersey: John Wiley and Sons, Inc.

Lam, K., & Li, F. (2008). The risk premiums of the four-factor asset pricing model in the Hong Kong stock market. Applied Financial Economics, 18(20), 1667.

Lehavy, R., & Sloan, R. (2008). Investor recognition and stock returns. Review of Accounting Studies, 13(2-3), 327-361.

Lettau, M., & Wachter, J. (2011). The term structures of equity and interest rates. Journal of Financial Economics, 101(1), 90.

Lynch, P. & Rothchild, J. (1989). One up on Wall Street. New York: Simon & Schuster/ Fireside.

Lynch, P. & Rothchild, J. (1994). Beating the street. New York: Simon & Schuster/ Fireside.

Malkiel, B. G. (2007). A random walk down Wall Street: the time tested strategy for successful investing. New York: W. W. Norton & Company.

Mateev, M., & Videv, A. (2008). Multifactor Asset Pricing Model and Stock Market in Transition: New Empirical Tests. Eastern Economic Journal, 34(2), 223-237.

Mohanty, S., & Nandha, M. (2011). Oil Shocks and Equity Returns: An Empirical Analysis of the US Transportation Sector. Review of Pacific Basin Financial Markets and Policies, 14(1), 101.

Montier, J. (2005). Global equity strategy: the folly of forecasting: ignore all economists, strategists and analysts. New York: Dresdner Kleinwort.

Neff, J. & Mintz, S. L. (1999). John Neff on investing. New York: John Wiley and Sons, Inc.

Novak, J., & Petr, D. (2010). CAPM Beta, Size, Book-to-Market, and Momentum in Realized Stock Returns. Finance a Uver, 60(5), 447-460.

Reese, J. P., & Forehand, J. N. (2009). The guru investor: how to beat the market using history’s best investment strategies. New Jersey: John Wiley and Sons, Inc.

Reilly, F. K.,& Brown, K. C. (2003).Investment Analysis and Portfolio Management (7th edition).Oxford: International Thompson Business Press.

Roubini, N. & Mihm, S. (2010). Crisis economics: a crash course in the future of finance. New York: Allen Lane.

Sharma, M., & Preeti, T. (2009). PREDICTION OF STOCK RETURNS FOR GROWTH FIRMS-A FUNDAMENTAL ANALYSIS. Vision, 13(3), 31-40.

Shiller, R. J. (2000). Irrational exuberance: the national bestseller that will help you survive in today’s stock market. New York: Broadway Books.

Sorensen, E., & Ghosh, S. (2010). Rewarding Fundamentals. Journal of Portfolio Management, 36(4), 71-76,10.

Tier, M. (2004). The winning investment habits of Warren Buffett & George Soros: harness the investment genius of the world’s richest investors. Hong Kong: Inverse books.

Train, J. (2000). Money Master of our times. New York: Harper Collins.

Wisdom, G. (2009). Wisdom on value investing: how to profit on fallen angels. New Jersey: John Wiley and Sons, Inc.

Wu, H. (2011). The Value and Size Effect – Are There Firm-Specific-Risks in China’s Domestic Stock Markets? International Journal of Economics and Finance, 3(3), 26-37.

Zorn, T., Dudney, D., & Jirasakuldech, B. (2009). P/E changes: some new results. Journal of Forecasting, 28(4), 358.

 

(Visited 85 times, 1 visits today)

About the author

Related Post

Leave a comment

Your email address will not be published. Required fields are marked *