MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM BANKING UNIVERSITY HO CHI MINH CITY NGUYEN MINH NGUYET FACTORS AFFECTING PRICE-TO-EARNINGS RATIOS OF LISTED COMPANIES ON HO CHI MINH CITY STOCK MARKET: PERIOD 2008 - 2016 GRADUATION DISSERTATION MAJOR: FINANCE - BANKING CODE: 7340201 HO CHI MINH CITY, 2018 MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM BANKING UNIVERSITY HO CHI MINH CITY NGUYEN MINH NGUYET FACTORS AFFECTING PRICE-TO-EARNINGS RATIOS OF LISTED COMPANIES ON HO CHI MINH CITY STOCK MARKET: PERIOD 2008-2016 GRADUATION DISSERTATION MAJOR: FINANCE - BANKING CODE: 7340201 SUPERVISOR DR. NGUYEN TRAN PHUC HO CHI MINH CITY, 2018 i ABSTRACT This dissertation studies the impact of influence factors on P/E ratios and to build regression models for estimating and forecasting P/E ratios. It employs data of 123 listed companies on HOSE over the period 2008 -2016. Besides, the purpose of the study is to provide empirical model foundations for investigating whether portfolios consisting of low P/E ratio stocks provide better than average returns.
The empirical researches are divided into two parts. Firstly, descriptive analysis, correlation analysis and regression process are used to examine the correlations. Regression estimation and selection of estimation are built up the estimation model. Finally, the author build up empirical model that investment in low P/E ratio stocks provides higher returns than that in high P/E ratio stocks by using the comparison between mean of overvalued stock return and undervalued ones.
The empirical results demonstrate that dividend payout ratios, growth rate, beta and return on equity have effect on P/E ratios and it is possible to invest in low P/E ratios to beat the market. Moreover, the research effect will be better with more factors employed. ii DECLARATION OF AUTHENTICITY I declare that this dissertation is my original work, gathered and utilized especially to fulfil the purposes and objectives of this study, and has not been previously submitted to any other university for a higher degree. I have mentioned all people who were significant facilitators of the work.
Ho Chi Minh City, May, 2018 Nguyen Minh Nguyet iii ACKNOWLEDGEMENTS First of all, I want to send my gratitude and respect to Doctor Nguyen Tran Phuc for his sharing, understandings and considerate supports to give me useful recommendations and guidances during my study. Finally, best regards to my lecturers, my friends, my classmates and my beloved BUH for their sharing and supports during my Bachelor program. Ho Chi Minh City, May, 2018 iv TABLE OF CONTENTS ABSTRACT. iii TABLE OF CONTENTS.
iv LIST OF ABBREVIATIONS. vii LIST OF TABLES. viii LIST OF FIGURES. ix Chapter 1 : INTRODUCTION.
THE NECESSITY OF THE THESIS. THE RESEARCH SUBJECT AND SCOPE OF THE STUDY. The research subject. Scope of the study.
The scientific contribution. The practical contribution .6 Chapter 2 : LITERATURE REVIEWS. The concept of P/E ratio. Use of P/E ratio for stock selection.
Factors affecting P/E ratios. Previous empirical studies. Previous empirical studies in the international context. Previous empirical studies in the Vietnamese context.
The position of this dissertation .26 Chapter 3 : RESEARCH METHOD AND DATA. Measurement of variables and hypothesis. Measurement of variables. Source of data.
Steps of data analysis and estimation. Selection of estimation method. Test of the obtained empirical model .35 Chapter 4 EMPIRICAL RESULTS AND DISCUSSIONS. Test of multicollinearity.
Selection of estimation method. Random Effect Model (REM). Fixed Effect Model (FEM). Redundant Fixed Effect-Likelihood Ratio.
Correlated Random Effects Hausman Test. Test of the obtained empirical model .52 Chapter 5 : CONCLUSIONS AND RECOMMENDATIONS. Limitations of this dissertation and new approaches in the future .60 APPENDIX 1: The descriptive statistics for all variables .60 APPENDIX 2: The covariance of variables .60 APPENDIX 3: Breusch-Godfrey Serial Correlation LM Test .60 APPENDIX 4: Heteroskedasticity Test: White's result for empirical model61 APPENDIX 5: Pooled OLS's result for empirical model .61 APPENDIX 6: Random Effect Mode's result for empirical model .62 APPENDIX 7: Fixed Effect Mode's result for empirical model .63 APPENDIX 8: Fixed Effect-Likelihood Test' result for empirical model .63 APPENDIX 9: Hausman Test's result for empirical model.63 APPENDIX 10: Data for estimating P/E from the empirical model .65 APPENDIX 10: Data for estimating mean of ‘higher than normal’ P/E ratio stocks and ‘lower than normal’ .66 vii LIST OF ABBREVIATIONS CAPM Capital asset pricing model EPS Earnings per share FEM Fixed effect model g Expected growth rate GDP Gross domestic product HOSE Ho Chi Minh stock exchange NYSE New York Stock Exchange OLS Ordinary Least squares P/E Price-to-earnings POLS Pooled OLS R Required rate of return REM Random effect model ROE Return on equity S&P 500 The Standard & Poor‟s 500 market index viii LIST OF TABLES Figure 3.1 : Factors affecting P/E raios………………………….1: The value of average Dividend Payout Ratio and P/E ratio on 2008 - 2016 period.2: The value of average Growth Rate and P/E ratio on 2008 -2016 period……………………………………………………………………………………….3: The value of average ROE and P/E ratio on 2008 -2016 period ……………………………………………………………………………………………….4: The value of average Dividend Payout Ratio and P/E ratio on 2008 - 2016 period………………………………………………………………………………….40 ix LIST OF FIGURES Table 2.1: Summary of international prior studies .2: Summary of Vietnam prior study .3: Summary of independent variables influencing on P/E ratios .1: Variables measurement in the author's analysis ………………………30 Table 4.1: The descriptive statistics for all variables .2: The covariance of variables .3: Breusch-Godfrey Serial Correlation LM Test …………………………….4: Heteroskedasticity Test: White's result for empirical model……………42 Table 4.5: Pooled OLS 's result for empirical model …………………………………43 Table 4.6: Random Effect Mode 's result for empirical model .7: Fixed Effect Mode's result for empirical model .8: Fixed Effect-Likelihood Tesst' result for empirical model .9: Hausman Test's result for empirical model .10: Summary of research’s results (5% significance) .11: Summary of research’s results (5% significance) .12: ‘Higher than normal’ P/E ratio stocks and ‘lower than normal’ P/E ratio stocks in 2016 .Error! Bookmark not defined.13: Mean of ‘higher than normal’ P/E ratio stocks and ‘lower than normal’ P/E ratio stocks in 2016. THE NECESSITY OF THE THESIS Security analysis and asset selection represents a crucial stage of the investment process.
The general approach in security analysis and asset selection is to identify underpriced and overpriced stocks. Apart from fundamental analysis based on applying appropriate stock valuation model to estimate the intrinsic value of the stock, the price-earnings (P/E) ratio or earnings multiplier approach is also used as an alternative approach by security analysts and investors in seeking worthwhile stocks. The P/E ratio of a stock is referred to as the ratio of its market price per share to its earnings per share. In reality, this ratio is widely used measure of the expected performance of firms (Anderson and Brooks (2005a and 2005b)).
The P/E ratio indicates the price that investors are willing to pay for each dollar of earnings. Investors may value the earnings of one firm differently from that of the other, thus P/E ratios differ across different firms, across different industries, and even across different markets. However, the P/E ratios may imply different stories and different market perspectives. A high P/E ratio stock may be considered as an overpriced stock or it may reflect investors‟ expectation about the high growth.
On the other hand, a low P/E ratio stock may reflect investors‟ pessimism about the future growth of the firm‟s earnings or it is may be an underpriced stock. In the practice of investment activities, investors attempt to find ways to generate higher expected returns while maintaining the same level of risk. Over the past decades, many investors have not believed in the hypothesis of market efficiency. Apart from different types of technical analysis, the P/E approach in security analysis has been conducted in this perspective with an aim of obtaining abnormal returns.
Many investors follow the principle of price-earning effect by investing in low P/E ratio stocks with a view that these stocks are undervalued. This 2 investment strategy seems to be consolidated by the findings of many significant empirical studies. For example, Nicholson (1960) provides evidence that low P/E ratio stocks on an average yield higher returns than those of high P/E stocks. Such difference is known as the value premium.
The results of Basu‟s test (1977) of the investment strategy of selecting low P/E stock also suggest that investment in low P/E stocks may provide positive abnormal return. Basu‟s methodology is as follows: (i) Ranking 650 stocks in accordance with their P/E ratios; (ii) setting up five equal-sized P/E ranked portfolios from the stocks; (iii) calculating monthly rate of returns of each portfolio over the subsequent year; (iv) running a regression of the monthly excess returns of each portfolio against the corresponding excess market index return. The results of Basu‟s test indicate that portfolios containing low P/E ratio stocks provided alphas or higher risk-adjusted returns as compared to those P/E ratios. However, the P/E ratio reflects investors‟ expectation about the growth potential of a stock as well as the risk involved (Bodie, Kane and Marcus, 2014).
Low P/E ratios may be due to its low growth potential of due to its high risk involved. P/E ratios may also differ across industries. From this perspective, an investment in a low P/E ratio stock may not be always a guarantee for abnormal returns. To this point, a question may come out in one‟s mind is: what are relevant approaches for identifying “really” low P/E ratio stocks or “relatively” low P/E ratio stocks? One approach that can be used for identifying “relatively” low P/E ratio stocks is to conduct a regression of firms‟ P/E ratio on their determining factors.
The obtained empirical model is then used to estimate a firm‟s „normal‟ P/E ratio. Based on the identified a firm‟s „normal‟ P/E ratio, investors can identify whether the firm‟s stock is over or under priced. However, this approach may not be relevant for individual investors in general due to its technical natures. Apart from the empirical studies investigating whether portfolios consisting of low P/E ratio stocks provide better than average returns, a number of recent studies focus on examining the factors affecting the P/E ratios (Loughlin (1996), 3 Sushil Kumar Bhadu and Warne (2009), Shamsuddin, Hiller (2004), Muhammad, Azam, (2010)).
However, these studies do not explicitly point to the possibility of using the obtained models as a tool for identifying “relatively” low P/E ratio stocks. In the Vietnamese context, the country‟s stock market is still a young one, though experiencing almost twenty years of development. The market has grown significantly and rapidly in both the number of stocks listed and value of market capitalization. However, making investment decisions based on "herd mentality" rather than professional strategies is still popular among Vietnamese investors, especially individual investors.
The “herd mentality” or “crowd psychology” was clearly seen when the country‟s stock market was hit by the global financial crisis Nguyen Kim Tung (2008). According to Nguyen Kim Tung (2008), about two- third of total investors on Vietnamese stock market were individual. Vietnamese individual investors tend to possess limited financial knowledge and have no skills of portfolio management. They are likely to imitate the crowd‟s investment decisions without their own careful judgement and consideration.
For example, there was a warning in 2007 that the prices of Vietnamese stocks were higher than their intrinsic value by 30%, but individual investors continued making buy orders. When the market was on the way of plummeting since March 2007, local investors appeared to be in a terribly panicking mood, having sold out stocks as fast as possible. The “herb mentality” phenomenon actually has contributed to creating instable situations on the Vietnamese stock market. As a result, the stock prices may diverge considerably from their intrinsic value.
This reality suggests the need of improving investment knowledge and skills for individual investors.