Investors rely on massive amount of fundamental and technical information to make profitable investment decisions. Advocates of efficient market theory believe that stock prices reflect everything that is known about a company and hence can be predicted based on fundamental analysis, while proponents of technical analysis attempt at forecasting future security prices based on historical data. However, quantitative measures indicating stock price movements in relation to these factors are not entirely understood. The main purpose of this study is to identify the most important technical and fundamental variables that dictate capital gains at firm level for companies in the energy sector, specifically those involved in oil and gas exploration and production.
Vast amount of data and information regarding the movement of major indices such as S&P500 and DOW is available. Such studies provide a bigger picture on the health of the equity market and of the economy but lend less than needed support to investors who are focusing on a specific sector. The main focus of this research is firm level analysis of oil and gas exploration industry because it is an important element of every well-diversified portfolio.
A multivariate regression model with fixed cross-section effects is employed to examine the effects of fundamental and technical variables on movements of stock prices. Quarterly data for 39 companies from June-1997 to March-2007 was collected and the dependence of stock price relative to the S&P sector index (RELSP) on return on investment (ROI), current ratio (CURR), gross profit margin (GRPRMARG), dividends paid per share (DIV) and trading volume (TRVOL) was analyzed.
The results show that the dependence of RELSP is statistically significant on TRVOL (p-value: 0.0000), ROI (p-value: 0.0702) and GRPRMARG (p-value: 0.0334). For all else constant, on average as TRVOL increases by 1%, RELSP increases by 8.6%; as GRPRMARG increases by 1%, RELSP increases by 2.8% and as ROI increases by 1%, RELSP increases by 0.1%. These results are in accordance with the available literature; as the corporate executives become more efficient (ROI rises), the company increases its market share (GRPRMARG rises) and trading volume increases (TRVOL rises), the value of stock prices increase (RELSP rises).
Also, the model shows that the effects of CURR (p-value: 0.1787) and DIV (p-value: 0.5745) on RELSP are statistically insignificant. However, a nonlinear trend pertaining to DIV and CURR was revealed. The analysis shows that initially as DIV increases RELSP increases but investors start to penalize companies as a greater percentage of earnings are paid in dividends and not retained to be invested in increasing shareholder value. Similarly, it was found that initially as CURR increases RELSP increases but after a certain point stock prices are penalized for increased amount of uninvested cash in hand.
Moreover, the model shows that mean systematic effect of all variables ignored in the model is approximately 4.6% (p-values = 0.00000). Thus, this model must be employed with other variables such as seasonal effects inflation, number of shareholders, investor’s perception of the health of the economy etc.
1 comment:
I have received many questions/comments/ideas re. the analysis presented here and wanted to provide a some clarification.
Firstly, stock prices are NOT solely driven by the variables included in this model. As mentioned in the second last paragraph - The effect of all variables ignored in the model is significant (p-values = 0.00000.
Moreover, the model definition will change for firms in other sectors. Also, the behavior of the model can change after any major event such as fall of Bear Stearns or 911.
Some takeaways from this study are - a) look at both fundamental and technical variables in making investing decisions. b)Do not be blinded by dividends paid as there is a nonlinear trend pertaining to dividends.
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