Determinants of Stock Prices - A Firm Level Analysis of the Energy Sector

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.

Bottom line, investors must employ both fundamental and technical variables in making investing decisions so as to maximize profits.

EMC - A BULL in the bear market

EMC Corporation (EMC), involved in development, delivery and support of information infrastructure, is traded on NYSE and is one bull among the bears.

I recommended EMC to one of my close friends this summer and since then EMC has shown a solid upward movement (except in November - the story of every stock). This recent dip presents a great opportunity to load EMC in your portfolio.

Technical Analysis:
EMC stock price moved sideways for the last 3 years, but has had a very good run (more than 50% gains) in the past one year. The % increase in stock price in next 1 year is estimated to be 2%, which is very low. However, the much-anticipated spin-off of VMware has been a huge success and I would not be surprised if EMC stock prices pound the estimates.

Fundamental Analysis:
EMC has a strong balance sheet. Also, EMC has better profit margins and revenue growth than the rest of the industry. However, when compared to its competitors, EMC shares have a higher PE and thus are more expensive.

Another parameter, corporate governance quotient (CGQ) indicating the relative strength of the management is one of the important parameters that long-term investors consider. EMC CGQ is better than 85% of S&P500 companies and better than 98% of the technology hardware and equipment companies.

Bottom line, BUY EMC at any dip.

Open Economy - TRADE effect on UnEmployment Rate

This article analyzes the degree with which the unemployment rate in United States is affected by the openness of the economy. US unemployment rate is measured on a monthly basis by the Bureau of Labor Statistics and the openness of US economy is defined as the share of international trade in U.S. GDP, given by the ratio of Exports and Imports to GDP (TRADE).

Quarterly data on UR and TRADE from year 1973 through 2002 was analyzed using the least square linear regression method to evaluate the effect of TRADE on UR for US economy.

Firstly, our analysis shows that UR and TRADE are inversely related to each other. The correlation coefficient between UR and TRADE was observed to be -0.645855. The negative correlation coefficient value suggests that as TRADE increases and the economy becomes more open, UR goes down. Also, the absolute value of the correlation coefficient (0.645855) is big indicating that there is a clear inverse trend between UR and TRADE.

Secondly, based on the data our model shows that if TRADE increases by one percentage point, we can expect average UR to decrease by 0.17 %. The model estimated the effect of TRADE on UR with a high level of significance (p-value = 0.0000). Also, the coefficient of determination (a tool to assess the fit of the model) was obtained as 0.42, which means that approximately 42% of the variation in UR can be attributed to TRADE.

Lastly, the model estimated that hypothetically if the US economy be closed for TRADE, average UR can be expected to be just over 9%. In other words this means that the average effect of all other variables not included in the model is expected to be 9% on UR.

Before analyzing any deeper, it must be stressed that UR changes as the balance of trade shifts between export and import. This point has not been evaluated in this model but it is expected that UR will decrease when export > import. This is due to the fact that as companies start exporting more, the demand for goods and services increase and consequently they hire more labor to keep up with the increased pressure on production. Similarly, one can expect that UR will increase when import > export because as US imports more goods and services produced in foreign nations, pressure on production eases and as a result companies become more likely to lay-off work-force.

Bottom line, these results show that unemployment rate in US like in any other nation depends on the overall health of the economy and not on TRADE alone. With that said, if all other factors influencing the economy, such as housing market, credit crunch and politics, remain constant such that unemployment rate depends on TRADE alone, unemployment rate decreases as the economy becomes more open to trade. One reason is the fact that as the economy becomes more open to TRADE, jobs are created especially in industries, such as transportation and construction, that support both export and import in some form.

Tracking Picks - PEP, KO, JSDA

Pepsico, Inc. (PEP)
First Recommendation - BUY (03/05/2007)
Performance - ~ 6% gain in last 2 months
Reason behind excellent performance - The Street's tumble in late Feb-07 stressed increased market volatility; consequently investors are now turning to defensive stocks such as PEP.
Outlook - Positive. Pepsi should continue to benefit from its international business and broad product line. Also, in early May Pepsico announced 25% increase in its annual dividend; this should attract more investors.
Current Recommendation - BUY.

Coca-Cola Co. (KO)
First Recommendation - SELL (03/20/2007)
Performance - ~ 10% gain in last 2 months
Reason behind excellent performance - KO reported a phenomenal 2007 Q1.
Outlook - Positive. It looks like KO has been revived by its management. I still prefer PEP over KO because of its bigger product line that includes cereals and chips. But, I notice that people are appreciating Coke ZERO more and more every day.
Current Recommendation - Upgraded from SELL to HOLD.

Jones Soda Co. (JSDA)
First Recommendation - BUY (03/20/2007)
Performance - ~ 11% gain in last 2 months
Reason behind excellent performance - Strong marketing strategy; JSDA's management is doing a great job of marketing its product as healthy and by putting its consumer's picture on its bottles.
Outlook - Neutral. Though, JSDA's market share has been increasing, it reported lower than expected profits in 2007 Q1.
Current Recommendation - HOLD only if you can handle high risk. Also, JSDA is currently expensive with a PE of 116.

Tracking Picks - NYX, DJO, CAT, XOM

NYSE Euronext, Inc. (NYX)
First Recommendation - BUY (02/03/2007)
Performance - ~ 10% decline in last 3 months
Reason behind lagging performance - Very often there is no connection between the company's fundamentals and its stock price. NYX is one such example. All NYX did in last 3 months was successfully merge with Europe's best and in return it experienced a hard fall. To some extent the recent downgrade of NYX by Goldman Sachs triggered its sell-off on the Street. The Goldman Sachs report basically recommended a SELL on NYX and a BUY on NASDAQ, rationalizing that NASDAQ is better poised to succeed in the US market. However, I believe the single biggest reason to get into NYX is its exposure to the European market not the US market.
Outlook - Positive. Recently, NYX reported a solid Q1 2007, which did not include earnings from Euronext. I believe NYSE-Euronext will beat all estimates in upcoming quarters once the revenue from Euronext starts flowing in.
Current Recommendation - BUY. Currently, the street is not on board with NYX, which makes investing in NYX very risky. However, I believe NYX can bring big gains.

DJO Incorporated (DJO)
First Recommendation - BUY (02/10/2007)
Performance - ~ 11% decline in last 3 months
Reason behind lagging performance - Problems with the integration of the Aircast business. On 05/08/2007 DJO posted a 40 percent jump in operating expenses and consequently a fall in 2007 Q1 earnings causing its share price to fall by approximately ~ 17% in one day.
Outlook - Dim short term outlook. DJO cut its 2007 full-year profit forecast because of increasing costs of inventories. This will also constrain increasing market share in the 2007.
Current Recommendation - SELL. In my opinion investing in an orthopedic device company is a great way to play the baby-boomer trend. I think investors should look into other better established players of the industry with broader product line such as Zimmer Holdings Inc. (ZMH) and Stryker Corp. (SYK).

Caterpillar Inc. (CAT)
First Recommendation - BUY (02/20/2007)
Performance - ~ 12% gain in last 3 months
Reason behind excellent performance - International exposure and thriving commodity market.
Outlook - Positive. US housing market is expected to get better by the end of 2007 and this is good news for CAT.
Current Recommendation - BUY.

Exom Mobil Corp. (XOM)
First Recommendation - BUY (03/05/2007)
Performance - ~ 15% gain in last 2 months
Reason behind excellent performance - Strong market for Oil.
Outlook - Positive. An oil company is a must have in any well diversified portfolio, and in my opinion XOM is the best oil company. Also, XOM is one of the most loved company by the mutual funds biggies which makes it a low risk.
Current Recommendation - BUY.

Tracking Picks - AUY, SBUX, MO, DENN

Yamana Gold Inc. (AUY)
First Recommendation - BUY (12/26/2006)
Performance - ~ 15% gain in last 4 months.
Reason behind good performance - Rising inflation and strong market for gold and copper.
Outlook - Positive. In current economic times, I believe gold must be a part of every well diversified portfolio, and the best way to play gold is AUY. AUY is the fastest growing intermediate gold company and is setting an example for the rest of the industry. On 04/24/2007 Yamana Gold reported that Q1 2007 production figures were ahead of budget. In my opinion, although AUY's momentum has stalled in last couple of weeks, it is poised to go much higher.
Current Recommendation - BUY.

Starbucks Corp. (SBUX)
First Recommendation - BUY (12/31/2006)
Performance - ~ 11% decline in last 4 months.
Reason behind lagging performance - Meeting (not beating) analyst estimates.
Outlook - Positive. Omnipresent Starbucks is committed to expand its business in more and more countries, the opening of its first store in Romania on April 8th being the latest example of its ongoing expansion.
Current Recommendation - Analyze Starbucks 2007 Q2 report coming out tomorrow (05/03/2007) for short term prospects. BUY for long term investing.

Altria Group Inc. (MO)
First Recommendation - BUY (01/10/2007)
Performance - ~ 5% gain in last 4 months.
Reason behind good performance - KRAFT spin-off, dormant litigation environment.
Outlook - Positive. A great value stock paying a good dividend (current yield is = ~ 5%); minor setbacks due to unforeseen lawsuits are possible.
Current Recommendation - BUY.

Denny's Corp. (DENN)
First Recommendation - SELL (01/25/2007)
Performance - ~ 12% decline in last 3 months.
Reason behind lagging performance - Falling same-store sales and guest traffic, in addition to high debt and low market share.
Outlook - Negative. Though Denny's management has been doing a lot to refinance its debt, it is proving to be just not enough.
Current recommendation - AVOID

Sell Dell

Dell Inc., a supplier of personal computers worldwide is traded on NASDAQ under the symbol of DELL, and in my opinion it sits on the SELL block.

Dell is involved in the design, development, manufacture, marketing, sale, and support of various computer systems and services.

In my opinion, anyone who owns it must dump it and those looking to invest should pass it. I am convinced, because I am now questioning the ethics of its management.

On March 30th this year, Dell announced delay (beyond the due date of April 4th) in filing its annual report for fiscal year 2007 with the SEC due to accounting irregularities. "The Audit Committee's investigation has identified a number of accounting errors, evidence of misconduct, and deficiencies in the financial control environment," Dell reported in a press release. As a result of this ongoing investigation into company's methods for recognizing revenue, the preliminary financial results for fiscal year of 2007 will be restated to reflect necessary adjustments in accounting estimates. The conclusion of this independent investigation can adversely affect the currently estimated numbers and growth between the current and prior year periods (which, even with the accounting irregularities, are strictly OK).

Dell is now expected to file form 10K with the SEC on April 18th providing an explanation for incorrect accounting and financial reports and establishing compliance with all SEC and NASDAQ requirements. I believe investors are still not selling DELL because they are waiting to know about the nature and severity of accounting errors made, which I think is a huge investing mistake. Regardless of what the error actually is (and however big or small it may be), trying to answer such questions will not mean much because an accounting mayhem almost always exposes the weakness of the company’s internal controls over financial reporting and effectively casts a doubt on the ethical functioning of the higher management. When a company starts making numbers, it is being irresponsible towards shareholders and I truly believe it is time to sell.

Bottom line, SELL DELL. When you can't trust the management's ethics, just run - questions about details can (and should) be saved for later.