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Research Project Effect of Financial Performance on Stock Price

Submitted By: Syed Mudassar Jawad MBA # 4 (Evening) Reg No: 2920-FUIEMS-MBA-2008

Introduction Researcher has researched on the topic Impact of financial performance on stock price . For this purpose researcher has choosed two Automobile Companies and applied Ratio analysis to evaluate their performance and the Impact of financial performance on Stock price . Researcher has checked the relationship between Performance and stock price by using Correlation test .

Background :

Stock investing is perhaps the most talked about form of investing. Stocks create hype because they are volatile and sensitive to various factors. With the current economic landscape and dismal performance of bourses worldwide, we can observe that stock prices are affected on a much larger scale than usual. Knowing the answer to this will enable you to buy and sell at the right time.

Broad Area of Study : Researcher has applied Ratio analysis to evaluate the performance of a company . Accounting is defined as an information system receiving its input from

various financial transactions, processing these transactions and giving as output the financial statements and other reports that will enable the users to make suitable decision dealing with business and economic entities. The records of the transactions are summarized into two major statements known as 'financial statements' or 'final accounts'. Hence broad area of my study is Finance.

Specific Area of Study :

My specific Area of study is Ratio Analysis . The most prevalent method of analyzing a balance sheet is through ratio analysis. The ratio analysis can be for a single year or it may extend to more than one year. The ratios can also be compared with similar ratios of others concerns to make a comparative study.

First, all ratios will be worked out for each year and each set of comparable items. The ratios worked out will be put in the context of a trend over several years. They will be compared with similar companies/ standard ratios. i) ii) for the year concerned, and Over a period of time.

Any number of ratios can be prepared by comparing any two figures available in the balance sheet or profits and loss account or both. But to serve its purpose, the figures compared should be meaningful, having a link between them, and should satisfy the needs of the person who analysis the financial statements.

Ratios are also classified differently on different bases. The mostly used one is the financial classification under which the ratios are broadly divided into the following five classes:

Liquidity ratios concerned with the short term solvency of the concern or its ability to meet financial obligation on their due dates.

Activity ratios concerning efficiency of management of various assets by the concern. Leverage ratios concerning stake of the owners in the business in relation to outside borrowings or long term solvency.

Coverage ratios concerned with the ability of the company to meet fixed commitments such as interest on term loans and dividend on preference shares and

Profitability ratios concerned with the profitability of the concern.

Rationale of Study : This study is focused on performance analysis and impact on stock

prices .This will help the investors to decide where to invest and how to examine the performance of a company . This will guide others to make their investment decision . as it will reveal the true picture of companies performance and relative fluctuations in stock prices .

Objective of study : Research objective is to check the relationship between Financial Performance

and Stock Price .Researcher has applied statistical measures to check the relationship between variables i-e, week ,strong , positive or a negative relationship .

Scope of study : As finance has a very vast scope and researcher has focused on

performance analysis by applying ratio analysis. Researcher has also observed stock market effect of performance. Review of literature :

Following is the literature review to support my study . Financial Performance Analysis: The most prevalent method of analyzing a balance sheet is through ratio analysis. The ratio analysis can be for a single year or it may extend to more than one year. The ratios can also be compared with similar ratios of others concerns to make a comparative study. (Chidambaram, Anbumani and et al). Current Ratio

The ratio is worked out by dividing the current assets of the concern by its current liabilities.

Current Ratio

Current ratios indicate the relation between current assets and current liabilities. Current liabilities represent the immediate financial obligations of the company. Current assets are the sources of repayment of current liabilities. Therefore, the ratio measures the capacity of the company to meet financial obligation as and when they arise. Textbooks claim a ratio of 1.5 to 2 is ideal; bit in practice this is rarely achieved. This ratio is also known as working capital ratio.

Acid Test Ratio

Acid Test Ratio =

Quick assets represent current assets excluding stock and prepaid expenses. Stock is excluded because it is not immediately realizable in cash. Prepaid expenses are excluded because they cannot be realized in cash.

One of the defects of current ratio is that it does not measure accurately to meet financial commitments as and when they arise. This is because the current assets include also items that are not easily realizable, such as stock. The acid test ratio is a refinement of current ratio and is

calculated to measure the ability of the company to meet the liquidity requirements in the immediate future. A minimum of 1: 1 is expected which indicates that the concern can fully meet its financial obligations. This also called as Liquid ratio or Quick ratio.

Profitability Ratios

Gross Profit Ratio

Gross Profit Ratio

A comparison with the standard ratio for the industry will reveal a picture of the profitability of the concern. Also the ratio may be worked out for a few years and compared to verify if a steady ratio is maintained. Net Profit Ratio

Net Profit Ratio

This ratio serves a similar purpose as, and is used in conjunction with, the gross profit ratio.

Earnings/ Share

Earnings per share

The numerator indicates the funds available for distribution as dividend to equity share holders. As the name indicates the ratio indicates the earnings made by the company per equity share. A comparison with the ratio for similar companies will indicate whether the company is using its capital effectively or not. (Eccles, Herz, Keegan, and Phillips et al, 2001)

Impact Of Financial Performance On Stock price: We suggest that marketing actions can influence financial markets as well asconsumption markets. They can affect stock prices indirectlythrough market share and profitability, and directly by altering the perceptions of analysts and investors . The process that shapes perceptions in financial markets helps determine the expected value and liquidity of the firm. ( Epstein and Birchard et al, 2000).

A firm's ability to generate positive cash flow from operations can also affect the power and legitimacy of shareholders.Cash flows from operations can also indirectly affect shareholder urgency by influencing market perceptions. In determining the value of a firm

( Lovett, MacDonald and et al,)

distinctiveness of retail firms might want to use some different ratios or some ratios in a different way than if analyzing industrialized firms. For industrialized firms there appears to be little need to examine return on sales disjointedly from other profitability ratios. However, for retail firms, return on sales should be analyzed separately from profitability ratios. (J. Gombola and J. Ketz) (Summer, 1983)

EPS ratios are mean reverting over several years. EPS including extraordinary items has a faster adjustment than EPS excluding extraordinary items. (Zvi Davis and C. Peles) (Oct., 1993),

Company performanceLogically, the stock price of a company should go up if its financial performance is good, and vice versa. However, you will notice that most of the time, when the financial results are announced, as long as they reflect analysts' expectations, regardless of whether the reports bear good or bad news, stock prices will usually not show much movement. (By Securities Industry Development Corporation)

Theoretical Frame Work:

Stock Price

Financial performance

Dependent Variable Research Question: How financial performance effect Stock Price ?

Independent Variable

Hypothesis: H0: There is no relationship between Financial Performance and Stock price H1: There is some relationship between Financial Performance and Stock price

Methodology:

Researcher has collected secondary data of Toyota Indus motor from Indus motor web site and Atlas Honda Cars From Atlas Honda Car Website and Stock prices from KSE.com and applied correlation to check relationship between Financial Performance and stock Price.

Analysis from excel sheet;

Reference: 1) Prof. C. Jeevanadam, Sardar Vallabhbhai Institute of Textile Management, Coimbatore, Notes on Financial Statements, Short Term Programme on Financial Management at Bannari Amman Institute of Technology, Sathyamangalam on 05.01.2005. 2) Principles of Accounting, Dr. Vinayagam, P. C. Mani, K. L. Nagarajan, Kalyani Publications, New Delhi, 2002. 3) 4) Financial Management, Dr. R. S. Kulsherestha, Kalyani Publications, New Delhi,2002 Dr. B. K. Behra, Class notes on Costing and Management,IIT-Delhi,2003

Eccles, Herz, Keegan, and Phillips 2001; Epstein and Birchard , Journal of the Academy of Marketing Science Retrieved From google.

Lovett, MacDonald / FINANCIAL PERFORMANCE , Retrieved from net Securities Industry Development Corporation, Retrieved from net http://www.jstor.org. Gombola, J. Michaael. and ketz, Edward J.(summer, 1983), Financial ratio pattern in retail and manufacturing organizations, Financial Management, Vol. 12, No. 2, Blackwell Publishing on behalf of the financial management association international, pp. 45-56, retrieved on 02.06.09, 14:16, from http://www.jstor.org.

Choi, D.S., Frederik,. Hino, Hisaakki,. Min, Kee, Sang,. Nam, Oh, Sang,. Ujiie, Junichi. (spring Summer, 1983), Analyzing Foreign financial Statements: The use and misuse of international ratio analysis Jouranl of international Busines studies, Vol 14, No. 1, Palgrave Macmillan Journals, pp. 113131, retrieved on 02.06.09, 14:23, from http://www.jstor.org.

Chabotar, john, Kent.(Mar. Apr., 1989). Financial Ratio Analysis comes to Non-Profits The Journal of Higher Education, Vol. 60, No. 2, Ohio State University Press, pp. 188-208, retrieved 02.06.09, 13:34, from http://www.jstor.org.

Feroz, E. H., Kim, S., Raab, R. L.,(Jan., 2003), Financial Sstatment Analysis:A Data Envelopment Analysis Approach, The Opreational Research society, Vol. 54, No. 1, Palgrave Macmillan Journals, pp. 48-56, retrieved 02.06.09, 13:40, from http://www.jstor.org.

Nelson, K. Karen, (Apr., 1996), Fair value Accounting fro Commercial Banks: An Empirical Analysis of SFAS No. 107, The Accounting Review, Vol. 71, No. 2, American Accounting Association, pp. 161-182, retrieved 02.06.09, 14:08 from http://www.jstor.org.

Busse, Meghan, (summer, 2002), Firm financial Condition and Airline Price War, The RAND Jopurnal of Economics, Vol. 33, No. 2, Blackwell Publishing on behalf of the RAND Corporation, pp. 289-318, retrieved on 02.06.09, 14:06, from http://www.jstor.org. Lee, F. Cheng, and Wu, Chunchi, (Apr., 1988), Expectation Formation and Financial Ratio Adjutment Processes, The Accounting Review, Vol. 63, No. 2, Amercian Accounting Association, pp. 292-306, retrieved on 02.06.09, 14:06, from http://www.jstor.org. Barth, E. Mary, (Jan., 1994), Fair Value Accounting: Evidence from Investment Securities and the Market Valuation of Banks, The Accounting Review, Vol. 69, No. 1, Amercian Accounting Association, pp. 1-25, retrieved on 02.06.09, 14:00, from http://www.jstor.org.

ANALYSIS