FINANCIAL RATIOS AND STOCK MARKET PRICES OF QUOTED DEPOSIT MONEY BANKS IN NIGERIA

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ABSTRACT

This study examined the influence of financial ratios on stock market prices of banks in Nigeria; specifically, the study aims at (i) determining the extent to which Return on Assets affects stock prices of quoted deposit money banks in Nigeria (ii) examining the predictive power of Cash Deposit Ratio on stock prices of quoted deposit money banks in Nigeria (iii) investigate if Debts to Total Assets Ratio influences the stock prices of quoted deposit money banks in Nigeria (iv) find out the effect of Net Asset Per Share on stock prices of quoted deposit money banks in Nigeria (v) evaluate the relationship between Earnings per Share and stock prices of quoted deposit money banks in Nigeria. The study adopted the ex-post-facto research design and data covering 7-year period 2009-2015 were collated from annual reports of banks and the Nigeria Stock Exchange daily official list. Panel multiple regression was used to estimate the relationship between these financial ratios and stock prices. Stock prices were adopted as the dependent variable, while the independent variables included Return on Asset (ROA), Cash Deposit Ratio (CDR), Debts to Total Asset Ratio (DTAR), Net Assets Per Share (NAPS) and Earnings Per Share (EPS). The result emanating from this study revealed the following: (i) returns on assets had about 47% correlation with stock price, suggesting a positive but statistically insignificant association with stock prices of selected banks in Nigeria (ii) cash deposit ratio showed a negative and significant association with stock price with a beta coefficient of -0.8531 (iii) debt to assets ratio showed a negative effect on stock prices and this association fails to be statistically significant at 5%. The beta coefficient was -0.7294 (iv) The relationship between net asset per share with stock prices negative coefficient of -0.0137. The result was not statistically significant at 5% level of significance (v) Earnings per share (EPS) was found to have a significant and positive association with stock prices of money deposit banks and the statistical significance is within the acceptable bound of 5%. The beta coefficient of EPS was 0.1170. The study therefore recommends among others that financial analysts and prospective investors should rely on earnings per share and cash deposit ratios in predicting the behavior of stock prices in Nigerian banks, and that government, policy makers, accounting standards setters and the monitoring authorities should require listed firms to disclose accurate, relevant and sufficient information in their financial statements, as these information affect stock price movements, and are guides to financial analysts and prospective investors in making rational investment decisions.

 

 

 

 

 

 

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TABLE OF CONTENTS

 

Cover page                                                                                                                              i

Title page                                                                                                                                 ii

Declaration                                                                                                                                iii

Certification                                                                                                                             iv

Dedication                                                                                                                                      v

Acknowledgements                                                                                                                vi

Abstract                                                                                                                                   vii

List of Tables                                                                                                                                xii

 

CHAPTER 1: INTRODUCTION

1.1      Background to the Study                                                                                               1

1.2      Statement of the Problem                                                                                            3

1.3      Objectives of the Study                                                                                                         4

1.4      Research Questions                                                                                                      4

1.5      Research Hypotheses                                                                                                   5

1.6      Significance of the Study                                                                                                     5

1.7      Scope and Limitation of the Study                                                                                 6

1.8      Operational Definition of Terms                                                                                 6         

CHAPTER 2: LITERATURE REVIEW  

2.1      Conceptual Framework                                                                                                8

2.1.1    Financial Ratios                                                                                               8

2.1.2    Financial Ratio Analysis                                                                                           8

2.1.3    Returns on Assets                                                                                                                  10

2.1.4    Cash Deposit Ratio                                                                                                     10

2.1.5    Debts to Total Assets Ratio                                                                                        11

2.1.6    Net Assets Per Share                                                                                                          11

2.1.7    Earnings Per Share                                                                                                              11

2.1.8    Objectives of Financial Statements Analysis                                                                           12

2.1.9    Advantages of Ratio Analysis                                                                                        13

2.1.10  Significance of Financial Analysis to Stakeholders                                                    15

2.1.11   Types of Financial Ratio Analysis                                                                               17

2.1.12    Profitability Ratios                                                                                                           19

2.1.13    Liquidity Ratios                                                                                                           22

2.1.14    Credit Risk/Solvency Ratios                                                                                          24

2.1.15    Efficiency Ratios/Assets Management Ratios                                                         28

2.1.16    Valuation Ratios/Investment Ratios                                                                         34

2.1.17    Cash Flow Indicators Ratios                                                                                        39

2.1.18    Limitations of Using Financial Ratios                                                                            44

2.1.19    Concept of Stock Price                                                                                                46

2.1.20    Stock Price Determination                                                                                           47

2.1.21    Stock Price Movements and Monetary Variables                                                        50

2.1.22    Stock Market Development and Economic Growth                                                            52

2.1.23    Nigerian Stock Market Experience                                                                          53

2.2        Theoretical framework                                                                                                     57

2.2.1     Random Walk/Efficient Market Hypothesis                                                             58

2.3       Empirical Review                                                                                                          59

2.4      Summary of Literature Review                                                                                            87

 

CHAPTER 3: METHODOLOGY

3.1       Research Design                                                                                                                 88

3.2       Population of the Study                                                                                                    88

3.3       Sample and Sampling Technique                                                                                 88

3.4        Method and Sources of data collection                                                                               89

3.5       Research Variables and Measures                                                                                 89

3.5.1    Dependent Variable                                                                                                            89

3.5.2    Independence variables                                                                                                 90

3.6       Model Specification                                                                                                    91

3.7       Data Analysis Techniques                                                                                                91

 

CHAPTER 4: DATA PRESENTATION AND ANALYSIS

4.1       Descriptive Analyses                                                                                                          92

4.2       Panel Unit Root Test at First Differencing                                                                       94

4.3       Panel Cointegration Analysis                                                                                              95

4.4       Granger Causality Test                                                                                               96

4.5       Test of Hypotheses                                                                                                     99

4.5.1    Hypothesis I                                                                                                                100

 

4.5.2    Hypothesis II                                                                                                                         102

 

4.5.3    Hypothesis III                                                                                                                  103

 

4.5.4    Hypothesis IV                                                                                                                 105

 

4.5.5    Hypothesis V                                                                  106

 

CHAPTER 5: SUMMARY, CONCLUSION AND RECOMMENDATIONS

 

5.1       Summary of Findings                                                                                                 107

5.2       Conclusion                                                                                                                         108

                                                                                                                       

5.3       Recommendations                                                                                                              108

5.4       Contributions to Knowledge                         109

5.5       Suggestions for Further Studies                                          110      References                                     111

Appendices                                                                120

 

 

 


 

LIST OF TABLES

2.1      Summary of Empirical Review                                                80

4.1      Results of Descriptive Statistics                                                  92

4.2      Results of Panel Unit Root Test                                                    94

4.3      Panel Cointegration Test Results             96

4.4      Granger Causality Test Results                                               97

4.5      The Hausmann Test Results                                100

4.6      Panel Fixed Effect Multiple Regression                                      101

 

 

 

 

 

CHAPTER 1

INTRODUCTION


1.1       BACKGROUND TO THE STUDY

Investments in the stock market require sufficient and adequate knowledge and understanding of the environments surrounding the stock market. It is needful for an investor and a potential investor to have this understanding because of the associated degree of risk involved in investment decisions. Risk is an element or probability that the unexpected may occur and adequate precaution ought to be taken to forestall it. In view of the possibility that an investor may lose his investments, it is essential to assess or evaluate investment opportunities to minimize the occurrence of this risk. One of the ways of evaluating the potentials of an investment is through the use of financial ratios.  Financial ratios are simply relationships between two or more figures in the financial statements which ultimately give direction as to the performance of the firm. These relationships are established to measure the success or failure of managerial decisions in the light of the movement in stock prices. According to Remi (2005), the firm stock prices have direct relationship with managerial efficiency, which is one of the signals of firm performances.

Apart from satisfying legal requirements, financial reporting is aimed at providing investors and analysts with the information needed to assess the operational results and financial standing of a firm for the purpose of making informed investment decisions. Stock prices often times serve as the basis for the assessment of whether a firm is breaking even or not. These prices are relevant metrics of returns to stakeholders, therefore the value attached to them and their direction of movement matters so much to both existing and prospective investors in the capital market. Over time, financial ratios have been used as proxies to predict the stock market prices of firms (Remi, 2005). This notwithstanding, many still question the efficacy of financial ratios in predicting stock prices. The need to find out the extent of the predictive power of financial ratios on stock prices in the banking industry motivated the study.

Prominent among the classes of ratios used to assess the risk, health, performance and status of a firm are profitability ratios, liquidity ratios, solvency ratios, efficiency ratios, valuation ratio and investment ratios (Lui & O’Farrell, 2009). These ratios are of paramount importance to investors as they serve as a mirror to the investor. Investors are not in a position to access the performance of the company in which they are intended to invest without these ratios. Rational investors use those financial ratios and other disclosures to assess the risk and the value of the firm. This assists in a more rational investment decision. 

Profitability ratios assess the performance of an entity in terms of how much profit it can generate from its operations. If a profitability ratio is relatively higher as compared to the competitor(s) or industry averages, or previous years’ same ratios, then it is taken as indicator of better performance of the bank.  Liquidity ratios emphasize an entity’s financial capacity to meet its cash and collateral obligations without incurring unacceptable losses. The ability of an entity to efficiently meet both expected and unexpected cash flows and collateral needs without adversely affecting either daily operations or the financial condition of the institution is of utmost importance. Inefficient liquidity management does not only reduce profitability but may ultimately lead to financial distress in an organization. Solvency ratios, otherwise known as gearing, debt, or financial leverage ratios measure the extent to which a firm relies on debt financing rather than equity. Equity valuation ratios are used by investors to compare a stock's per-share price (market value) to its book value (shareholders' equity).

In this study, Return on Asset (ROA), Cash Deposit Ratio (CDR), Debts to Total Asset Ratio (DTAR), Net Asset per Share (NAPS) and Earnings per Share (EPS) have been selected to represent financial ratios. This is because an investor looks at the various aspects banks’ performance before investing his funds. These ratios were selected to cover the major aspects of the banks’ performance usually considered by investors. The study therefore evaluates the relationship between these ratios and stock prices of deposit money banks in Nigeria.

 

1.2       STATEMENT OF THE PROBLEM

Banks in Nigeria operate under a turbulent economic environment, characterized by massive deceleration in money supply and credit, poor asset quality, undercapitalization, a weakening exchange rate, fluctuating inflation rate, decline in global oil prices, poor corporate governance, weak risk management framework, shortage of foreign currencies and high cost of capital (Adedoyin, 2011). However, a bank’s stock price is susceptible to all of these factors which it has no control over. A section of the market participants has attributed the trend in stock price movements to the availability of accounting information while another camp of analysts opined that exogenous variables (non-accounting information) sparked off by government’s loose monetary policies is the formidable cause (Stephen and Okoro, 2014). However, from literature there are several factors in share price determination in the capital market; these factors are either accounting or non accounting information (Khanagha, 2011; Cheng, Shamsher, and Annuar, 2008).

Several studies have shown that non-accounting parameters such as speculation, gambling, and forced sales form the basis for the determination of share prices (Cheng, Shamsher, and Annuar, 2008; Francis and Schipper, 1999).  Incidentally, only few studies in Nigeria (Oyerinde, 2009; Umar and Musa, 2013) have attempted to provide empirical evidence of the relationship between stock price movements and accounting information, and these few studies are not specifically in the banking sector. This study which favours the philosophy that accounting information serves as determinants of stock price movement in the capital market intends to empirically investigate the extent to which financial ratios influence stock prices in the Nigerian banking sector.

 

1.3       OBJECTIVES OF THE STUDY

This study examined the relationship between financial ratios and stock price movements in deposit money banks in Nigeria. Specifically, the study is to:

i.      Determining the extent to which Return on Assets affects stock prices of quoted deposit money banks in Nigeria.

ii.     Ascertain the predictive power of Cash Deposit Ratio on stock prices of quoted deposit money banks in Nigeria.

iii.   Investigate the influence of Debts to Total Assets Ratio to the stock prices of quoted deposit money banks in Nigeria.

iv.   Identify the effect of Net Asset Per Share on stock prices of quoted deposit money banks in Nigeria.

      v.     examine the relationship between Earnings per Share and stock prices of quoted deposit money banks in Nigeria.

 

 

1.4    RESEARCH QUESTIONS

The following research questions were posed for the study:

(i)             What is the relationship between Return on Assets and stock prices of deposit money banks in Nigeria?

(ii)           How does Cash Deposit Ratios influence stock prices of deposit money banks in Nigeria?

(iii)         To what extent does Debts to Total Assets Ratios affect stock prices of deposit money banks in Nigeria?

(iv)          What is the relationship between Net Asset Per Share and stock prices of deposit money banks in Nigeria?

(v)           How does Earnings Per Share influence stock prices of deposit money banks in Nigeria?


1.5       RESEARCH HYPOTHESES

Based on the objectives, the following hypotheses were formulated:

(i)             There is no significant relationship between Return on Assets and stock prices of deposit money banks in Nigeria.

(ii)           There is no significant influence of Cash Deposit Ratio on stock prices of deposit money banks in Nigeria.

(iii)         There is no significant effect of Debts to Total Assets Ratio on stock prices of deposit money banks in Nigeria

(iv)          There is no significant relationship between Net Assets Per Share and stock prices of deposit money banks in Nigeria.

(v)           There is no significant influence of Earnings Per Share on stock prices of deposit money banks in Nigeria.

 

1.6       SIGNIFICANCE OF THE STUDY

Past studies on financial ratios and stock price movements have concentrated on the developed countries. This study will contribute to understanding of the interrelationships between financial ratios and stock price movements in Nigeria, specifically in the banking sector. The findings of this study will contribute to knowledge about the behavior of stock prices in relation to financial ratios of listed deposit money banks in developing countries like Nigeria. This information will provide financial institutions, consultants, investors, analysts, and entrepreneurs with the necessary tools to predict stock prices for rational investment decisions. The findings will also provide information for policy makers involved in promoting investment. It will also provide a basis for further research in financial ratios focusing on developing countries. Specifically, the study is hoped to be of immense benefit to the following stakeholders.

Scholars and researchers may also wish to use the findings of this study as a basis for further research on these unresolved issues of optimal financial decisions. It will guide the Capital Market Authority, and other regulatory authorities in making regulations regarding data to be disclosed in the financial statements for optimal investment decision. Findings of this study are intended to provide shareholders and investors with information regarding the determination of the market value of their investments. Potential investors would also make use of the findings of this research to be able to make more informed decisions, as they will be aware of the financial ratios to look out for before they invest in a firm.

 

1.7       SCOPE AND LIMITATION OF THE STUDY

This study is restricted to the determination of the relationship between financial ratios and stock prices. The study is restricted to listed deposit money banks in Nigeria, notwithstanding the fact that stock prices cut across all firms listed on the Nigerian Stock Exchange (NSE). Four (4) financial ratios, each from the major classes of ratios were computed from financial statements of banks for period of seven years (2009 – 2015). The period covers from when deposit money banks in Nigeria were mandated to operate a uniform financial year end (31st December) to date.

 Analyses for this study are based on values obtained from the annual financial statements of these banks and daily stock price list by Nigerian Stock Exchange (NSE). The reliability of findings of this study is limited to the reliability of these published values.            Also, only five ratios namely, Returns on Assets, Cash Deposit Ratio, Debts to Total Assets Ratio, Net Assets Per Share and Earnings Per Share are examined.


 

1.8     OPERATIONAL DEFINITION OF TERMS

 

Stock Price: The highest amount someone is willing to pay for the stock, or the lowest amount that it can be bought for.

Investment: An asset or item that is purchased with the hope that it will generate income or will appreciate in the future.

Profitability: The degree to which a business or activity yields profit or financial gain.

Liquidity: The measure of the ability of a debtor to pay its short-term obligations.

Solvency: The ability of a corporation to meet its long-term obligations

Leverage: The amount of debt used to finance a firm's assets.

Efficiency: A level of performance that describes a process that uses the lowest amount of inputs to create the greatest amount of outputs.

Ratio: The quantitative relation between two amounts showing the number of times one value contains or is contained within the other.

Return on Assets: An indicator of how profitable a company is relative to its total assets.

Cash to Deposit ratio: The ratio of how much a bank lends out of the deposits it has mobilized.

Debt to Total Assets Ratio: The percentage of total assets that are financed by creditors, liabilities, debt.

Net Asset Per Share: An expression for net asset value that indicates the value per share for a fund or a company.

Earnings Per Share: This is the ratio of the conversion of the naira amount of profit to a per share basis.

 

 

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