ANALYTICS REPORT

TO: INVESTMENT COMPANY

FROM: OLIVIA LAWSON

SUBJECT: COMMON VIOLATIONS IN REGRESSION

DATE: 17 OCTOBER 2020

Introduction
In the data findings below at linear regression was conducted in order to help determine which
data variables are significant for predicting Earnings per Share, as well as a check for any
violations within the regression. This information can then be used to help show companies that
would be good investors based of the significance of these variables. By completing the analysis
and violation check, we were able to find that Earnings Before Tax and Operating Margin are
significant when predicting Earnings per Share. However, we may want to perform significance
testing on Pre-tax Margin due to multicollinearity with Operating Margin.

Data Analysis
Regression Equation
^
Earnings per Share=4.13+2.03 E - 10 ( Earnings Before Tax ) −0.06 ( Operating Margin )−0.004 ( Pre−Tax Margin

Fit of the Model

The R2 = 0.16 tells us we are 16% of the way to perfectly predicting earnings per share using this
model.
The standard error of 4.25 tells us our predictions of earnings per share are off by an average of
$4.25/share

Test of Joint Significance

H0: None of the explanatory variables are significant.
HA: At least one of the variables is significant.
Due to the p value being significantly less than an alpha level of 0.05, we can conclude that at
least one of the explanatory variables is significant in evaluating Earnings per Share.

Earnings Before Tax

H0: Earnings Before Tax is not significant when predicting Earnings per Share.
HA: Earnings Before Tax is significant when predicting Earnings per Share.
Due to the p value being very close to zero, which is less than our alpha of 0.05, we can reject
the null and prove that Earnings Before Tax is significant when predicting Earnings per Share.
As Earnings Before Tax increases by 1 dollar, Earnings per Share increases by $2.03E-10/share,
on average and all else constant.
Based off the residual plot for Earnings Before Tax, there could be cause for heteroskedasticity.
Therefore, the p value and standard error could be off, however, the p value is so small that it is
most likely still significant.

Operating Margin
H0: Operating Margin is not significant when predicting Earnings per Share.
HA: Operating Margin is significant when predicting Earnings per Share.
Due to the p value being very close to zero, which is less than our alpha of 0.05, we can reject
the null and prove that Operating Margin is significant when predicting Earnings per Share.
As operating margin increases by 1 percentage point, Earnings per Share decreases by $-
0.064/share, on average and all else constant.
The residual plot for Operating Margin shows to be random, therefore, we can trust our
coefficient and the significance testing for this variable.

Pre-Tax Margin
H0: Pre-Tax Margin is not significant when predicting Earnings per Share.
HA: Pre-Tax Margin is significant when predicting Earnings per Share.
Due to the p value of 0.701 being greater than our alpha of 0.05, we cannot reject the null and
fail to prove that Pre-Tax Margin is significant when predicting Earnings per Share.
This coefficient is not significant enough to make an interpretation.
The residual plot for Pre-Tax Margin shows to be random, therefore, we can trust our coefficient
and the significance testing for this variable.

Multicollinearity and Excluded Variables:

The correlation between Operating Margin and Pre-Tax Margin are very similar, so this could be
cause for multicollinearity. The correlation could be evidence as to why the Pre-Tax Margin does
not look significant due to it being a model with Operating Margin and excel is choosing to
emphasis, therefore, Pre-Tax Margin could be deemed significant with more testing.
After analyzing the residuals, there is no evidence of excluded variable. This tells us that the
variables that were not included are not throwing off our analysis or making the model less
reliable.
Company Comparison:
IBM: EBT = $7.04 billion Hewlett-Packard: EBT = $3.41 billion
OM = 10.65% OM = 0.05%
PTM = 9.32% PTM = 0.58%
^
Earnings per Share=4.13+2.03 E - 10 ( Earnings Before Tax ) −0.06 ( Operating Margin )−0.004 ( Pre−Tax Margin
IBM- ¿ 4.13+ 2.03 E - 10 ( 7.04 )−0.06 ( 10.65 )−0.004( 9.32)
= $ 3.4537 earnings per share
Hewlett-Packard-
¿ 4.13+ 2.03 E - 10 ( 3.41 ) −0.06 ( 0.05 )−0.004 (0.58)
= $ 4.1246 earnings per share
Based on the analysis above, I recommend investing in Hewlett-Packard because it has a higher
earnings per share than IBM.
Conclusion
By running this linear regression, we were able to find that Earnings Before Tax and Operating
Margin are significant when predicting Earnings per Share. This is a reliable model to use when
predicting Earnings Per Share due to both Operating Margin and Earnings Before Tax being
significant variables. It was shown that when Operating Margin increases by one percentage
point, then Earnings per Share decreases by 0.064/share. I would advise that when looking for
companies to invest in, look for companies with high Earnings Before Tax and with low
Operating Margin values. Also, after finding multicollinearity between Operating Margin and
Pre-tax Margin, I would advise to perform significance testing on Pre-tax margin to see if it is a
significant variable. For questions and next steps please contact Olivia Lawson via email at:
olawson@email.arizona.edu .

Appendix
Figure 1