1.
Introduction
If you win a lottery with million
amounts, then decide to invest that money in a stock market. How would you
decide to purchase the particular company’s stock?
Stock market is highly volatile and
it is quite difficult to predict future phenomena to make a good stock market
investment decision. Many researchers have suggested that Price Earning (P/E)
Ratio is a tremendous tool of stock analysis. The P/E Ratio can be calculated
using share price and dividing it by the company’s earnings per share. The
Price Earnings provide an idea that what potential investors are willing to pay
for the company’s earnings. The higher the PE means the market wants to pay
more to the company’s earnings with an expectation that high growth in the
future and vice versa.
There are several research
conducted in many countries regarding relationship between Price Earnings Ratio
and stock market investment decision. However, in the context of Nepal, very
few studies have done in terms of PE ratio. Even these studies have not showed
relationship with investment decision.
This research particularly focuses
to show relationship between PE ratio and stock market returns in Nepalese
companies, to demonstrate influence of PE ratio to make sound stock market
investment decision in Nepalese stock market.
2.
Literature Review
There are Basu’s (1977-1985) an extensive study on
listed on the New York Stock Exchange (NYSE) for the period between 1957 and
1971 finds that PE ratios on average earn significantly higher and
risk-adjusted rates of return. But in this study, researcher avoids those
companies which has PE ratio close to zero or negative. Similarly, Damodran
(2006) also indicates that ‘other thing remains equal’ positive relationship
between PE ratio and growth of the firms and states that higher growth firms
have higher PE ratio. Of course, other things are difficult to hold equal since
high growth firms, tend to have risk and high reinvestment rats. Further, H.
Solanki (2014) also concludes after analyzing 100 Indian listed companies that
investing in low P/E stocks creates sound possibility to generate better
returns. This study shows that performances of least P/E stocks are much better
in compare to higher P/E stocks. But this study limited up to BSE-100 indices.
If more indices will be taken then there will be more accuracy in results and
conclusion.
PE ratio can be an effective
investment strategy and has great influence on stock market investment decision.
A sixteen years (1994-2010) study done by Tze San On and others (2010) in
Malaysian stock exchange (KLCI) explores that the PE ratio could have been
employed to build successful investment strategies in predicting stock market.
This research suggests that high level of Price Earnings Ratio can lead an
increase in future stock performance. This study has tested only on whether PE
ratios could act as an indicator of economic recessions and unfavorable market
conditions in the coming future. Even a research in Pakistan chemical industry,
which has been done by Afzal and Tahir (2012) also reveals that PE ratio is an
effective decision making tool. But this research is only based on chemical
industry and hard to generalize in other context.
In the context of Nepal, there are
few studies have been done by some researchers in finance; however, there is no
any academic research regarding PE ratio. Joshi (2012) has done the research both
Nepalese banking and non-banking sectors and reveals that dividend per share is
a main motivating factors to invest in the Nepalese financial sectors. Even the
Earning per share (EPS) is not important factor to determine the stock price. This
study focuses only to show the relationship between dividend per share and
decision to make investment in a particular company. On the other hand, Phuyal
and sharma (2013) and Mahat (2007) have done some studies regarding volatility of
stock price and risk associated with it. They mention that high volatility
price indicates high risk in investment, but they fail to mention the reasons
of volatility of share price such as PE ratio. Bhattarai a Nepalese finance
analyst says in national newspaper ‘Kantipur daily’ (2011) that the ideal
number of PE ratio in Nepalese Banking Sectors 15 is justifiable. He also adds
in that article that despite the higher PE ratio investors are interested in
investing in stock in those companies that has high goodwill and strong
corporate governance. Bhattarai states a justifiable PE ratio and its relation
with investors’ interest on stock purchase; however, he is not able relate how PE
ratio motivates to make investment on stock market.
In order to evaluate investment
opportunities in the stock market the price-to-earnings ratio is an important
financial metric. Many authors and researchers make enormous efforts to study
this including Basu (1977, 1983) Doran et al (2010), Afzal and Tahir
(2012), Wan- Ting (2013), and H. Solanki
(2014) show that there is direct relationship between PE ratio and stock price,
which has great influence in stock market investment decision. However, there
is no any academic research regarding PE ratio conducted in Nepal. Only some studies regarding stock and risk
are found for literature. Paudel (2002) also highlights that the stocks of
commercial banks and other big corporations have been traded in Nepalese stock
market and Mahat (2007) adds that Nepalese stock market is highly volatile and
risky. If investors do not know how to protect themselves from potential loss,
they can miss their huge stock market investment.
3.
Significance of the Research
P/E ratio has a crucial role in the
investment community and this ratio reflects the market’s expectation of future
growth and firm risk (Wan-Ting, 2013). There are several studies regarding PE
ratio and stock price (for example, Damodran, 2006, H. Solanki, 2014) as well
as PE ratio and its effect on stock market investment decision (for example,
Tze San On and others, 2010, Afzal and Tahir, 2012) in different countries.
However, it is not found any solid research in this topic in Nepal. Some
research regarding the motivating factors of stock market investment, risk and
return, volume of stock trading and its effect on future price of stock have
done but have not concern to PE ratio. This paper can obviously be worthy for
those investors in Nepal who are taking risky stock market investment decision
without analyzing proper financial analysis (PE ratio). Since, this study can
significantly contribute not only as a further study of PE ratio (Investment
decision making theory) but it may be also prior study of PE ratio and its
relationship with stock market investment decision in Nepalese stock
market.
4.
Research Design
Methodological
Framework
The main aim of this study is to
examine the relationship between PE ratio and stock price of Nepalese companies
and to demonstrate the influence of PE ratio on stock market investment
decision in Nepal. Moreover, purposefully, this study is related with explanatory
studies. It will explain the relationship between variables such as
relationship between PE ratio and stock price, and PE ratio with stock market
investment decision making. Studies that
ascertain causal relationships between different variables can be termed
explanatory research (Saunders et. al, 2009)
Denscombe (1998) explains to
positivism that the aim of social research to discover the patterns and
regularities of the social world by using scientific methods. This study is going to show a relationship
between PE ratio and Stock price. First, it is required to calculate PE ratio
of the companies and to link calculated ratio with share price based on the
published financial report. In addition, to present an effect of PE ratio in
making stock market investment decision in practice, it is required know how an
investor personally analyses PE ratio before to buy the stock of the particular
company.
Researchers simply can select a
research method that fits their purposes (Weber, 2004). Positivism is considered
for this research question where universally accepted accounting formula and
quantitative analysis methods will be used.
It also accepts the assumption that researcher is independent of and
neither affects nor is affected by the subject of the research (Remenyi et al.
1998:33).
Strategy:
Financial
statements of the listed companies and personal experience of investors will be
gathered in this research. Since this research will consider mixed method of
research. A combination of quantitative
and qualitative research is called mixed method (Johnson and others, 2007).
Strategically,
this study is based on document-based strategies (Secondary data methods) where
published financial statements of different listed Nepalese companies will be
collected to establish relationship between PE ratio and stock price. In
addition, to illustrate influence of PE ratio to investors while making stock
market investment decision interaction-based strategies will be considered. For
this, survey with semi-structured questionnaire will be held to collect data.
Profit,
share price and number of issued share are required to calculate PE ratio
(Bondt and others, 1985). Since, it is impossible to collect primary data from
each company to calculate PE ratio. Moreover, to present an influence of PE
ratio on stock market investment decision, an interaction-based interview will
be held. Interaction (Semi-structured questionnaire) with respondents provides
an opportunity to discuss with them, and it also prevents the interview to be
out of topic.
Sampling:
Primary and Secondary Data:
Researchers prefer sampling, if it
is impractical to collect data from the entire population, time and budget
constraints. However, it does not mean that more useful information can be
collated from census rather than sampling. Sampling also provides valid
information to a population (Saunders et al, 2009).
Firstly, in order to calculate PE
ratio and show its relationship with stock price, financial Statements of
listed companies in Nepal will be collected. This can provide factual data of
the companies.
Nepal stock Exchange ltd (NEPSE) is
a registered company where four hundred and thirty seven (437) listed Nepalese
companies’ stocks are traded (NEPSE, 2015).
Therefore, the population of this research is the NEPSE listed
companies. NEPSE classifies listed companies based on their nature such as
banking (29), hotels (4), development banks (105), hydropower (7), finance
(69), insurance (22), and others (201).
Non-probability sampling method
will be used to select two hundreds (200) companies out of four hundred thirty
seven listed Nepalese companies. However, all commercial banks (29) will be
included in sampling. This priority in sampling is given to banking because
commercial banks stock transactions carry more than sixty percent transactions
at NEPSE (NEPSE, 2015). Similarly, listed Hotels and hydropower are very few in
numbers. Therefore, four hotels and seven hydropower listed companies will be
included in sampling. Rest of samples will be selected by ensuring at least
thirty percentages of each sectors are representing in sample.
Secondly, this study also
demonstrates the influence of PE ratio to investors on making the stock market
investment decision. This study is going to collect the data to show how PE
ratio can influence to buy the stock in Nepal. Since, all individual investors
in Nepal are population of this study.
However, in order to collect data
from that population, researcher selects NEPSE house to collect information
from investors or potential investors. Under judgmental sampling, respondents
will be selected from hundreds of visitors including professional visitors,
intermediaries and other visitors (750 visitors in average daily: NEPSE, 2015).
Five hundred (500) respondents will be sampled to ask semi-structured
questions. Researcher wants to collect information from not only professional
investors and intermediaries but also other causal visitors.
Interview with semi-structured
questions will be held. Questions include very basic things to gather
information about respondents understanding about PE ratio. Similarly, there
are other questions such as how they consider PE ratio to make investment
decision on stock market, how their investment decision may change with the
change in PE ratio of companies, and how they relate PE ratio and stock market
investment decision.
Semi-structured questionnaire
allows interviewee to talk freely throughout interview, at the mean time it
also facilitates to researcher to ask cross questions as per requirement.
Since, there is high possibility to get less error information from the
respondents.
In order to obtain high response
and accurate information from respondents, at the beginning of the interview a
clear purpose of this study and how this study can help you in the future will
be explained briefly. Moreover, for their time contribution (around half hour),
$50 amount of money will be also offered to ensure that respondents provide
enough time to talk with researchers.
Based on the answers of the
respondents the information will be analyzed to show the pattern of influence
of PE ratio on stock market investment decision.
Data
Analysis and Control Variable:
To calculate PE ratio the
accounting formula (Appendix 1) will be used. Similarly, regression analysis
will be used to present a relationship between PE ratio and stock price.
However, there are some control variables that may influence the output of the
research. According to Bennet and others (2011) there are other factors rather
than PE ratio to make investment decision. They explains that factors such as recommendation by investment
analysts, broker and research reports, friends, family and peers also plays
significant role to make investment decision on stock. Similarly, in the context
of Nepal, Bhattarai (2011) also states that investors are interested in
investing in stock in those companies that has high goodwill and strong
corporate governance rather than consideration of PE ratio.
Reliability
and Validity:
Firstly,
information will be collected from audited and published financial statements.
Similarly, accounting formulas and quantitative technique will be applied to
analyze the data. Secondly, this study has designed semi structured
questionnaire to ensure that researchers has an opportunity to ask cross
questions to avoid false information.
Construct
validity is used to ensure that the measure is actually measure what it is
intended to measure (i.e. the construct), and not other variables (Saunders et.
al, 2009). This study is focus to gain information regarding PE ratio and focus
to analyze to show its relationship with stock price and its effect on decision
making. Therefore, the measure is actually assessing the intended construct,
rather than an extraneous factor.
Since, audited and publically
published financial statements are obvious source of information to calculate
PE ratio of the companies. Similarly, NEPSE house is one of the best places
where investors or potential investors visit daily.
This study includes representatives
from all subgroup to increase the external validity of the output. Campbell (1966) explains that external
validity seeks for generalizability; to what populations, settings, treatment
and measurement of variables are in the center of research for external
validity. In sampling process, researcher will cover financial statements (200
companies’ statements) from all subgroups as mentioned by NEPSE. Similarly, for
survey, respondents will be selected not only professional investors but also
intermediaries and causal visitors.
Since, this study will concern to
minimize errors both in collection of information and analyze the information
for the acceptable output.
Ethical
Consideration and Limitations
This study is serious about the
ethical matters. Researcher will request to visitors at NEPSE to participate
voluntary but they will not be coerced. Similarly, respondents will be informed
clearly regarding propose of research and questions to be asked before
starting. Confidentiality is another matter while in collecting data for both
primary and secondary sources, and it also should be highly respected. The
participant will remain anonymous throughout the study and researcher will also
deal with person’s right service.
However, this study has certain
limitations. This study will gather secondary data mainly. Since, it relies on
the published financial statements of the companies. Similarly, researcher will
go to collect data at NEPSE just a day. Hence, a single day’s data collection
may not represent to all investors in Nepal.
Lastly, the researcher has specifically investigated the relationship
between PE ratio and stock price and its effect on investment decision e only
in the Nepalese context.
5.
Conclusion
In conclusion, this study basically
intends to find out the relationship between PE ratio and stock price and
effect of PE ratio on stock market investment decision in the context of Nepal.
Several studies regarding PE ratio and its relationship with other variables
have been done by academic researchers in other countries such as India,
Malaysia, United Kingdom, and USA; however, there is no any such study in the
context of Nepal. This study has significance contribution not only theoretical
to establish relationship between PE ratio and stock price of Nepalese
companies but also provide a confidence to potential Nepalese investors to
analyze stock by using PE ratio before to make stock market investment
decision.
This study basically based on
accounting PE ratio formula and regression analysis. However, in the future,
other researcher may apply other quantitative technique such as correlation to
analyze data. On the other hand, this study based on one day survey in a
particular place. Since, future study can cover the more demographic respondents
to make more reliable outcome of the research in the same topic.
In addition, PE ratio may not influence stock
market investment decision. According to Bennet and others (2011) and Bhattrai
(2011) there are other variables that night affect stock market investment
decision such as recommendation by investment analysts, family, friends, and so
on. Therefore, variables other than PE ratio that affect investment decision
might be areas for future studies.
Total words: 2363
Reference:
Afza, Talat, and Ms Samya Tahir.2012. "Determinants of
price-earnings ratio: the case of chemical sector of Pakistan". International Journal of Academic
Research in Business and Social Sciences 2,
no. 8 : 331-343.
Amir, E., Harris, T.S.,
Venuti, E.K., 1993. “A Comparison of the Value Relevance of U.S. versus
non-U.S. GAAP Accounting measures using Forms 20-F reconciliations”. Journal of
Accounting Research, Vol. 31, pp. 230-264.
Anderson, Keith, and Chris Brooks. 2006. "Decomposing
the price-earnings ratio". Journal of Asset Management 6, no. 6: 456-469.
Anderson, Keith, and
Chris Brooks. 2006."The Long‐Term
Price‐Earnings
Ratio". Journal of Business Finance & Accounting 33, no. 7‐8:
1063-1086.
Bacidore, Jeffrey M., John A. Boquist, Todd T. Milbourn, and
Anjan V. Thakor. "The search for the best financial performance
measure." Financial
Analysts Journal 53, no. 3
(1997): 11-20.
Basu, Sanjoy. 1977. "Investment performance of common
stocks in relation to their price‐earnings ratios: A test of the efficient market
hypothesis". The journal
of Finance 32, no. 3: 663-682
Bernard, Victor L., and Jacob K. Thomas. 1990. "Evidence
that stock prices do not fully reflect the implications of current earnings for
future earnings". Journal
of Accounting and Economics 13,
no. 4 : 305-340.
Bhattrai, Rabindra. 2011. “Banks see sharp fall in PE
ratios”.Kantipur Daily, 22 August.
Bondt,
Werner FM, and Richard Thaler. 1985. "Does the stock market
overreact?."The Journal of finance 40, no. 3: 793-805.
Campbell, D.T., Stanley, J.C. 1966. Experimental and
Quasi-Experimental Designs for Research. Skokie, Il: Rand McNally.
CAMPBELL, J. Y. and SHILLER, R. J. 1988. “Stock Prices, Earnings, and
Expected Dividends”. The Journal of Finance, 43: 661–676.
doi: 10.1111/j.1540-6261.1988.tb04598.x
Chen, Qi, Itay
Goldstein, and Wei Jiang. 2007. "Price informativeness and investment
sensitivity to stock price". Review of Financial Studies 20, no.
3
Damodaran, Aswath. 2007. “Valuation
approaches and metrics: a survey of the theory and evidence”. Now Publishers
Inc.
http://0search.proquest.com.prospero.murdoch.edu.au/docview/463448386?accountid=12629.
Denscombe, M. 1998. The Good Research Guide, Open University
Press, Buckingham , Philadelphia.
DiGregorio, Dean W.
2014. "What accounting students should know about the price-earnings
ratio". Journal of Finance and Accountancy 16 : 1.
Doran, James S. and
Kevin Krieger. 2010. "Implications for Asset Returns in the Implied
Volatility Skew". Financial Analysts Journal 66 (1): 65-76.
http://0search.proquest.com.prospero.murdoch.edu.au/docview/219228869?accountid=12629.
E. Bennet, Dr. M.
Selvam, Eva Ebenezer, V. Karpagam, S. Vanitha. 2011. “ ‘Investors’ attitude on
Stock Selection Decision in International of Management and Business Studies”.
Vo 1. 1 (2).
Easton, Peter D. 2004.
"PE ratios, PEG ratios, and estimating the implied expected rate of return
on equity capital." The accounting review 79, no. 1: 73-95.
Gupta, Ashish. 2007.
"Price Earning Ratio Helps Pick Stocks". McClatchy - Tribune
Business News, Dec 10. http://0search.proquest.com.prospero.murdoch.edu.au/docview/463448386?accountid=12629.
H. Solanki,
Ashvinkumar. 2014 “Relationship between
P/E Ratio and Stock Return”. Volume-3, Issue-8, • ISSN No 2277 - 8160
Houmes, Robert, and
Inga Chira. 2015."The effect of ownership structure on the price earnings
ratio—returns anomaly". International Review of Financial
Analysis 37 : 140-147.
Jains, Dhiraj and Nakul
Dashora. 2012. "A STUDY ON IMPACT OF MARKET MOVEMENTS ON INVESTMENT
DECISION : AN EMPIRICAL ANALYSIS WITH RESPECT TO INVESTORS IN UDAIPUR,
RAJASTHAN". Researchers World 3 (2): 78-88. http://0-search.proquest.com.prospero.murdoch.edu.au/docview/1017534176?accountid=12629.
Joshi, Rabindra. 2012.
"Effects of dividends on Stock prices in Nepal". NRB Economic
Review 24, no. 2: 61-75.
Kasilingam, R. and G.
Ramasundaram. 2011. "Price Earnings Multiples: Actual
Determinants." SCMS Journal of Indian Management 8 (3): 108-120.
http://0search.proquest.com.prospero.murdoch.edu.au/docview/896956421?accountid=12629.
Liem, P., & Basana,
S. 2012. “Price Earnings Ratio and Stock Return Analysis (Evidence from
Liquidity 45 Stocks Listed in Indonesia Stock Exchange)”. Jurnal Manajemen
Dan Kewirausahaan (Journal Of Management And Entrepreneurship), 14(1),
7-12. doi:10.9744/jmk.14.1.7-12
Mahat D. L. 2007.“Price
Volatility and Measurement of Risk”. SEBON Journal. Vo III :17-20.
Nepal Stock Exchange
ltd. 2015. http://www.nepalstock.com.np/
Paudel Pd. Narayan.
2002.“Investing in Shares of Commercial Banks in Nepal: An Assessment of Return
and Risk Elements”. Economic Review: Occasional Paper
Phuyal, Niranjan, and
Narayan Prasad Sharma. 2013. "Stocks Returns, Trading Volume and
Volatility at the Nepalese Stock Market". SEBON Journal .
Saha, Anup Kumar, Md Bhuiyan, and Ashiquer Rahman. 2013.
"Predictability of stock price fluctuation based on price earnings ratio:
Evidence from dhaka stock exchange." The
Cost and Management 41, no. 2
: 13-17.
San Ong, Tze, Yantoultra Ngui Yichen, and Boon Heng Teh.
2010. "Can High Price Earnings Ratio Act As An Indicator Of The Coming
Bear Market In The Malaysia?". International
Journal Of Business And Social Science 1,
no. 1 .
Sarantakos, A. 1993. Social research. Melbourne: MacMillan
Saunders, Mark, 1959, Philip Lewis 1945, and Adrian Thornhill.
2009. Research methods for business students. 5th ed. New York:
Prentice Hall.
Shen, Peter.2000.
"The P/E ratio and stock market performance." Economic
Review-Federal Reserve Bank of Kansas City 85, no. 4 : 23-36.
Trevino, Ruben, and Fiona Robertson. 2002. "P/E ratios
and stock market returns". JOURNAL OF FINANCIAL PLANNING-DENVER- 15, no. 2: 76-85.
Walavalkar, Nikhil.
2012. "Why PE Ratio-Based Allocation Makes Investment Sense
Analysis]". The Economic Times (Online), Oct 05. http://0
search.proquest.com.prospero.murdoch.edu.au/docview/1082306087?accountid=12629.
Walavalkar, Nikhil.
2012. "Why PE Ratio-Based Allocation Makes Investment Sense
Analysis]". The Economic Times (Online), Oct 05.
http://0search.proquest.com.prospero.murdoch.edu.au/docview/1082306087?accountid=12629.
Weber, R. 2004.“The Rhetoric of Positivism Versus
Interpretivism: A Personal ViewMIS Quarterly” Vol. 28 No. 1, pp. iii-xii
Wu, Wan-Ting Alexandra. 2013. "The P/E Ratio And
Profitability". Journal
of Business & Economics Research (JBER) 12, no. 1: 67-76.
Zikmund,
W.G., Babin, B.J., Carr, J.C., & Griffin, M. 2013. Business Research
Methods. 9th ed. Mason, OH: South Western Cengage Learning.
Zikmund, William G. 2013. Business research methods.
9th ed. Mason, OH: South-Western.
APENDIX -1
Price earnings ratio = Share price /Earnings per share
Earnings Per share = Net Profit after Tax/Total Numbers of
Issued Share
No comments:
Post a Comment