Waikato Management School

Dept of Finance

FINA511-13A
RESEARCH PAPER

Relationship Between Stock Return, Dividend-Price

Ratio, Price Earnings Ratio, Size, Market to book
Ratio, and Payout Ratio

Name :-Niranjan Sant

ID :- 1198724

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Contents
Abstract..................................................................................................................................................................3
1. Introduction........................................................................................................................................................4
2. Literature Review................................................................................................................................................6
3. Data and Sample.................................................................................................................................................9
3.1 Banking Sector............................................................................................................................................10
3.2 General Industrials......................................................................................................................................10
3.3 Industrial Engineering.................................................................................................................................10
3.4 Software and Computer services................................................................................................................11
4. Methodology....................................................................................................................................................11
4.1 Dividend Price Ratio....................................................................................................................................11
4.2 Price Earnings Ratio....................................................................................................................................12
4.3 Size..............................................................................................................................................................12
4.4 Market to Book Ratio..................................................................................................................................12
4.5 Payout Ratio................................................................................................................................................13
4.6 Stock Return................................................................................................................................................13
4.7 Regression Model.......................................................................................................................................14
5. Empirical Results...............................................................................................................................................15
5.1 Summary Statistics......................................................................................................................................15
5.2 Pearson Correlation Matrix.........................................................................................................................16
5.3 Regression Result........................................................................................................................................17
6. Conclusion.........................................................................................................................................................25
References............................................................................................................................................................28
Appendix...............................................................................................................................................................31

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Abstract

In this paper, I have examined the relationship between stock returns and
five variables, Dividend price ratio, Price Earnings ratio, Size, Market to book
ratio and Payout ratio, by examining this relationship I have attempted to
analyze investors approach and choice towards investing their money in
stock market. I have also tried to analyze what factors investors do take into
consideration while investing in any particular security or stock. For this
study I have collected the sample of 357 firms from Indian stock market and
divide the sample in four different sectors Banking Sector, General
industrials sector, Industrial engineering and Software and computer services
sector. I have used OLS regression in this study to study this relationship.
Results and findings of this paper show that, some variables are statistically
significant with stock return for each sector. Result of each sector is different
from each other. Investors approach is also different in each industry and
changes according to industry. There are different factors in each sector
which investors take into consideration, so therefore their strategies and
choices regarding investment differ from one sector to other.

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 1. Introduction

There are many studies in Corporate finance literature who have focused and
examined the relationship between stock return and other performance
variables. In this paper I have attempted to use Dividend Price ratio, Price
Earnings Ratio, Size, Market to book ratio, and Payout Ratio. Many studies in
literature have focused on developed markets but very few studies have
focused on Indian stock market, which is emerging and developing market.
This study has focused on Indian stock market, I have examined three major
sectors in Indian stock market General Industrial, Industrial Engineering and
Software and computer services. These three sectors contain major
industries in India like Tata Motors, Infosys, SKF, ABB, Thermax and many
others. I have attempted to analyze these sectors because these three
sectors have their major impact on Indian Stock market as I mentioned
earlier, these three sectors contain major Indian companies.

The main aim of this paper is to examine the predictability and relationship
between stock returns, D/P ratio, Price Earnings Ratio, Size, Market to book
ratio and Payout ratio. This study also examines the predictability of these
ratios to forecast the future stock returns. I have used the market to book
ratio in this study, this is motivated by findings of Fama and French(1992)
that shows that market to book ratio of individual stock can explain the
cross-sectional variation in stock returns. For determining market prices and
earnings of the stocks, book value and dividend could be very useful for
predicting stock price behavior and behavior of stock returns in future. Due
to this, one can construct very profitable and fruitful strategies on the basis
of dividend, book value and earnings.

According to the mispricing view, P/E effect mentions that stocks which have
low P/E ratio earn significantly higher returns than that of stocks which have

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high P/E ratios. Thus according to this mispricing view, there is inverse
relationship between portfolio return and P/E ratio. By using this approach
investor can earn significantly higher returns by investing in the stocks which
have low P/E ratio. In case of Market to book ratio,MtB effect states that,
stocks with high MtB ratio consistently obtain lower returns than those
securities which have high MtB ratio. Book value proxy for future cash flow
could be the one explanation for Market to book ratio's ability to predict
future stock return. Coming to Dividend price ratio, High D/P ratio shows that
the market is undervalued. Predictive power of D/P ratio is depends on role
of dividend in capturing some components in price which are permanent,
whereas predictability of P/E is because earnings is a very good measure of
business conditions, which explains the counter cyclic risk aversion. D/P
defines variation in real stock return in a much better manner on value
weighted index. Three ratios Price to earnings ratio, Market to book ratio,
and dividend price ratio have some same features one of the feature is that
all the ratios measure stock prices relative to fundamentals. So in this
respect this study is contributing in literature by showing the ability of these
ratios to predict stock returns.

With the help of this relationship of Stock return and different ratios, I will
also predict the choices of the investors and the preferences of the investor
regarding all this three sectors, whether investors are looking for capital gain
or they are looking for Dividend earnings. In case of these three sectors
investors have different approach towards investing in these sectors, some
sectors show that investors are more interested in capital gain whereas in
case of some sectors investors are holding these stocks for long term basis
and looking for Dividend gains. I have used dividend price ratio and its
relationship with stock return to examine whether investors are looking for
long term investment and looking for Dividend gain. Price earnings ratio is
used to examine whether investors are just looking for capital gain, Size is
used to measure the magnitude of the company and ultimately of that

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sector, Size and Stock return relationship has been used to examine
investors approach toward magnitude of the company and its market
capitalization, this has been used to examine whether investors are looking
for high magnitude stocks and whether size matters for them or not.

So main contribution of this paper is to elaborate the relationship between

stock returns and Dividend price ratio, Price earnings ratio, Size, Market to
book ratio, Payout ratio and examine the predictability of this variables of
future stock returns. And by comparing these variables to stock return I am
also analyzing investors approach towards selecting the stock and towards
their investment choices I have attempted to distinguish three sectors and
investor’s choices towards purchasing stocks from all these three sectors.

Rest of the paper is the structured as, in section 2 Literature review and
what other papers have examined about stock return and its relationship
with these ratios, section 3 includes Data and sample used for this study and
from where the this data has obtained, Section 4 has Methodology used to
calculate all the ratios used and the most important stock returns. Section 5
contains Empirical results and last Conclusion of the paper and future scope
of research in the same area.

2. Literature Review

There are many studies in corporate finance literature who have observed
the relationship between stock return and various financial ratios, but there
are very few studies who have observed this relationship in Indian context in
financial crisis period of 2008 - 2009 hence, my study will be focusing on
Indian markets finding the relationship between stock returns and various
performance variables.

According to the Banz(1981), small size firms have higher average stock
returns, but in case of average size and large size firms this size effect is not

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consistent. He also mentioned that size effect exists but it is not clear why
this effect exist, he was not clear with the fact that, size is a factor or it is
just a proxy for one or more true but unknown factors correlated with size.

Jeffrey Jaffe, Donald B. Keim and Randolph Westerfield(1989), concluded

that, there is significant earning price and size effects in US market when
estimated across all months during the 1951-1986 period. This study also
added that, there is difference between January and the rest of the year as
the coefficient on both E/P and Size are significant in January but in case of
other months, only E/P coefficient is significant outside January.

In Guler Aras and Mustafa Kemal Yilmaz(2008) they examined the

predictability of stock return taking into consideration 12 emerging markets
around the world. They have used, price-earnings ratio, dividend yield and
market-to-book ratio as predictable variables and covered the period of 1997
to 2003. This study finds variation in their findings, Market to book ratio
shows significant result in predicting stock return for one year period for
most of the emerging countries, But overall investor can forecast the
potential stock market return for one year period up-to certain extent by
using Market to book ratio, partially dividend yield ratio and price earnings
ratio. According to the authors investor can improve their predictability by
adding other variables like, consumer price index which shows the
macroeconomic changes in predicting stock return in the market.

Robert H. Litzenberger and Krishna Ramaswamy(1982) studied the

relationship between dividend yield and stock return. According to this
study,their results show that, there is positive but non-linear relationship
between dividend yield and stock return. But study also says that significant
dividend yield effects cannot pinned to information content in the prior
knowledge that firm will declare dividend of unknown magnitude.

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Keith S. K. Lam(2002) studied the relationship between stock return and β
Size (ME), Leverage, book to market equity ratio and earning price ratio in
Hong Kong stock market, in this study he has used Fama and French (FF)
approach. Result from this study shows that, three accounting variables book
to market, E/P, ratio and size really captured the cross sectional variation in
average returns over the period. Other variables like book and market
leverage also captured the cross sectional variation but effects of those
variables are dominated by Size, book to market equity and E/P ratio, Hence
those cannot be considered.

Pradosh Simlai(2009), In this paper Author has examined and reinvestigated

the performance of common stock return with two popular variables Size and
book to Market Ratio. According to their findings incorporation of time
varying conditional variance can significantly supports the impact of the
three risk factors, he also concluded that, because of this findings Fama and
French model is successful and unaffected by the incorporation of time
varying investment opportunity set. His study also finds positive and
significant relationship between size and Stock return.

In the study of Jeffrey Pontiff and Lawrence D. Schall(1995) they have

examined the predictive ability of the book to market ratio in Dow Jones
industrial average. According to their findings, Dow Jones Industrial average
book to market ratio is good predictor of market return than the other
variables like dividend yield, and interest rates. Author also mention that,
their findings are sample specific where predictive power of book to market
ratio occurs only before 1960. As after 1960 there is no significant
relationship.

Ian McManus, Owain AP Gwilym and Stephen thomas(2004) they observed

the relationship between stock return and dividend yield in UK stock market,
they have introduced the data related to earning to the asset pricing model

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in the form of payout ratio. In this study they have introduced payout ratio
and examines the relationship between payout ratio, dividend yield and
stock return. According to the result of this study, payout ratio does have
impact on dividend yield itself in explaining stock return.

Gabriel Perez-Quiros and Allan Timmermann (2000) have observed

difference ofvariation in stock return in different economic conditions and
tried to examine stock returns of both small firms and large firms. In that
study they have considered three factors firm size, economic and market
condition for analyzing and capturing sensitivity of expected risk and returns.
According to the findings of this paper, Interest rate is the vital factor for
sensitivity of stock return volatility, expected returns of the firm is also very
sensitive to this interest factor. In the recession phase stock return of small
firms are mostly affected, large firms stock returns also get affected in such
situation but compared to small firms it is less sensitive.

Kee Hong Bae, Jeong-Bon Kim(1998) in their study, they have taken the
sample data of Japanese firms. The main aim of their study was to examine
the usefulness of the two fundamentals, accrual earnings and book value of
equity share for the purpose of predicting stock returns. According to the
result of this study, both accrual earnings and book value of equity can
predict the stock return and investors and policy makers can build profitable
strategies by using this approach. Paper also mentioned that, book value
captures some aspects of equity value of stock which are not captured by
earnings.

Raj AggarwalTakatoHiraki and Ramesh P Rao(1992) examined the price to

book ratio effect in Japanese market. In this study they have observed that
stocks with high price to book value ratio have earn low returns whereas
stocks with low price to book ratio have high low stock returns. This study
has observed inverse relationship between stock return and price to book

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ratio in Japanese market. The result of this study also shows that, accounting
data is useful for deciding trading strategies in Japanese stock market
because investors can actually predict the stock return by calculating price
to book ratio.

JYH-LIN WU, YU-HAU HU and CHINGNUN LEE (2011) this paper tried to solve
the question whether dividend yield can actually predict the stock return
without short rates in UK stock market. For this study they have collected
monthly stock data for the period of 1923 to 2007. According to the findings
of this study, dividend yield can actually be predicted without short rates but
only if the forecast horizon is more than four months.

ChakerAloui, DucKhuong Nguyen and HassenNjeh(2012) in this paper they

have examined the impact of oil prices on Stock return in emerging stock
markets. In this study they have segregated the countries according to the
countries which are the largest importer of Oil, countries which are
moderately depend on oil and the countries which are largest exporter of oil.
In their study they have used data from 25 different countries for the period
of 1997 to 2007. According to their findings relevance of oil price risk is
conditional in case of emerging markets, also there is asymmetry in case of
stock return and significant when oil prices are rising. Their results also show
significant relationship between global market betas and stock returns of
emerging stock markets. But however they have also mentioned that, this
relationship Is negative when world market was falling down.

3. Data and Sample

For this paper I have collected all the data from DataStream database, I have
segregated the data sample in three sectors, Banking sector, General
Industrials, Industrial Engineering, Software and Computer services. I have

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collected the data sample for the period of May 2003 to May 2013. All the
ratios which, used as independent variables have been calculated
individually. All the data which is required to calculate these ratios have
been obtained from DataStream. Three sectors in total constitute 357 firms
altogether. This data consists of monthly average of Dividend price ratio,
Price Earnings ratio, Market to book ratio, Payout ratio and Size from May
2003 to May 2013.

Stock returns are calculated by dividend adjusted approach. For calculating

the return for the month of May 2003, I have downloaded the data for the
month of April 2003 as an Initial price of stock. After calculating all the
returns for every month, I have taken the average of all the returns of all
firms from May 2003 to May 2013.

Sectors Sample Size

   
Banking Sector 33
   
General Industrials 48
   
Industrials Engineering 146
   
Software And Computer Services 130
   
Total Sample Size 357

3.1 Banking Sector

In banking sector, I have included all nationalized banks in Indian stock

market. This sector includes some banking giants like, State bank of India,
Punjab National Bank, Bank of India, and Bank of Baroda. In this sector I have
included some major private banks like ICICI, Indusind Bank, HDFC bank,
these private banks are also have good market cap and these are also some
of the giant banks in India.

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3.2 General Industrials

This sector covers some wide variety of data as various manufacturing

companies are included in this sector. This sector has several companies
dealing in different areas of products like construction material, retail goods
product, and many others. This sector also includes some conglomerate like
3M India.

3.3 Industrial Engineering

As name suggests, this sector includes engineering companies and also

some forging companies. This sector includes some major automobile
companies like, Tata Motors, Ashok Leyland, Forbes, Mahindra and Mahindra,
these some companies are major players in Indian stock market with huge
market capitalization and have huge impact on index movement. Some
government owned companies are also there in this sector like, Bharat heavy
electrical, Bharat Bijlee, BEML, Nelco etc. Forging companies like Bharat
forge which is largest forging company in Asia became world’s second
largest forging company after acquiring Carl Dan Peddinghaus GmbH (CDP),
one of the largest forging companies in Germany, for an undisclosed sum.

3.4 Software and Computer services

In last several years software and IT sector in India has rapidly grown up and
now it is one of the important sector for Indian Stock market, so I have
included this sector in my study to analyze. Indian IT sector is in boom for
last several years and developing rapidly. In this sector, there are some IT
giants like Infosys, Wipro, Satyam computer services, Zensar Technologies,
Rolta India, HCL technologies etc. This sector is one of those sectors which
have huge impact on Indian stock market movements.

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4. Methodology

This study shows the relationship between stock return and various
performance variables like, Dividend price ratio, Earning price ratio, Market
to Book Ratio, Payout Ratio and Size. For calculating stock returns dividend
adjusted. I have calculated each ratio on monthly basis for every company
and then took the average of those ratios for each month for entire sample
period.

4.1 Dividend Price Ratio

For calculating this ratio, I have obtained monthly prices for all of the firms in
data sample and dividend per share from DataStream. Dividend data which
is obtained from DataStream is 12 moth rolling basis data.

Dividend Price Ratio = Dividend per Share / Price per Equity

Share
Dividend price Ratio is company's annual gross dividend paid divided by its
market cap or the dividend per share divided by price per share. This
dividend price ratio is typically used by researchers in finance where the
study of variability of this ratio is main concern.

4.2 Price Earnings Ratio

In general, high P/E ratio suggests that investors are expecting high earning
growth in future compared to the companies with low P/E Ratio. P/E ratio has
been calculated by dividing price per share with the EPS (Earning per share)
of that particular share. P/E ratio also calculated for every single firm in
sample and then average of P/E ratio is calculated. EPS for each firm in the
data sample is obtained from DataStream for 357 firms in all three sectors.

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Price Earnings Ratio has been calculated as:
Price Earnings Ratio = Market Value per Share / Earning Per Share

4.3 Size

Size which is also known as a market capitalization of the company. Size

represents the magnitude of that company. I have used size in my study to
examine its relationship with stock returns. I have also examined whether
investors make their investment decisions on the basis of Size or Market Cap
of the company. For calculating Size I have downloaded monthly prices of
the equities and number of outstanding shares from DataStream. Size is
calculated as:

Size = NOSH × Market Price of Equity share

Size also represents the total market price of the company.

4.4 Market to Book Ratio

Market to book ratio compares the book value and market value of the stock.
MtB ratio also indicates that whether stock is undervalued overvalued. Low
MtB ratio represents that stock is undervalued. With the help of this ratio,
investors can also access whether they are paying too much for the stock, if
company goes bankrupt immediately. This Ratio is obtained from
DataStream database, to examine its relationship with stock return. MtB
ratio is also useful to examine the window dressing in stock market.

Ratio is calculated as:

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4.5 Payout Ratio

Payout ratio briefly represents the earning paid to the shareholders of the
company. This ratio can be used by investors to know what company is doing
with its earning, whether company is retaining this earnings or paying out to
its shareholders. Low Payout ratio represents that company is not paying out
its earning and retaining them for future expansion plans or for future needs
of the company, whereas high payout represents that company is paying out
dividends. This ratio also indicates how earnings are supported by dividends.
This ratio is also obtained from DataStream database.

It is calculated as:

4.6 Stock Return

Stock return or rate of return also known as return on Investment is a ratio

which calculates the gain or lost of money on any investment relative to the
the initial money invested. In this paper I have calculated stock returns by
using dividend adjusted approach. I have obtained all the stock prices and
dividend paid per share data from DataStream database.

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According to this formula I have calculated stock returns for all the 357
companies in my dataset for the period of May 2003 to May 2013. This
formula calculates appreciation by increase in stock price plus dividend paid
if any, and then divided by initial or Original also known as Opening stock
price of the stock. Main sources of income for any investor in stock market is
the Increase in a stock price of the company and Dividend paid by the
company on investment, numerator of this formula shows total gain or loss
and dividend earned on investment and denominator shows initial stock
price or opening stock price.

4.7Regression Model

To examine the correlation between stock return and predictive variables I

have used OLS (ordinary least squares) regression. The regression equation
can be expressed as follow:

Y = α + β1X1 + β2X2 + β3X3 + β4 X4 + β5X5

Where,

Y =Dependent variable that is Stock Return.

α =Indicates the value of Y when all the values of
explanatory variables are zero.

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 β =this parameter indicates the average change in Y that
is associated with unit change in variable X.
X= Independent Variable.
X1 Dividend price ratio, X2 is Price earnings ratio, X3 is Size Variable, X4 is
Market to book ratio and X5 is a payout ratio, as mentioned before Y is
dependent variable that is Stock return.

5. Empirical Results

In this section I have tried to examine the relationship between stock return
and other variables like Dividend Price ratio, Price earnings Ratio, Size,
Market to Book Ratio and Payout ratio. In this section I examine the
correlation between stock return and predictive variables to analyze their
predictive ability. I have used this correlation to analyze investors approach
towards each sector and whether they invest in those sectors for capital gain
or for Dividend earning.

5.1 Summary Statistics

To begin with, Table 1 Shows summary statistics for all the five variables
used in this study, and also the stock return. This table also includes the
mean and standard deviation for stock returns and all other independent
variables. According to this table General industrial sector has highest
average stock return and also standard deviation, whereas banking sector
has lowest stock return and standard deviation in all sectors. But in case of
Dividend price ratio, Industrial engineering has the highest D/P ratio and
banking sector has the lowest one. Looking at the Size factor, banking sector
is huge in Size compared to any other sector and also way ahead of all the
sectors mentioned. From this we can conclude that Indian banking sector has
huge magnitude effect on Indian stock market. After banking, software
sector comes at number two in case of Size, IT sector is in boom in India and
its effect is clearly seen on Size and magnitude of that sector, So after

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banking, Software sector is the next most affecting sector in Indian stock
market. As i have mentioned earlier in this paper, I have covered this three
sectors because this sectors constitute the major Indian companies and
giants. In Banking all the nationalized banks and major banks have been
covered like, State bank of India, Punjab National Bank, Bank of Baroda,
Bank of India etc, and in software and computer service sector I have
covered all the major software giants in India like Wipro, Infosys, etc. Due to
this Size factors affects a lot.

Table. 1 Summary Statistics for all Sectors from May 2003 to May 2013

Stock Return D/P ratio P/E Ratio Size MtB Payout Ratio
Sectors Mean SD Mean SD Mean SD Mean SD Mean SD Mean SD

Banking Sector 0.054 0.118 0.029 0.009 9.833 3.349 109803237 6.50E+07 1.199 0.264 17.480 1.288

General Industrials 0.115 0.433 0.043 0.019 17.946 13.861 2052537 1.27E+06 1.443 0.539 17.180 5.708

Industrial Engineering 0.099 0.165 0.054 0.023 22.885 10.410 9518441 6.06E+06 2.263 1.056 19.530 2.264

Software and Computer Services 0.088 0.246 0.043 0.017 43.780 21.183 16844239 9.27E+06 2.257 1.049 12.111 4.459
Note:- This table includes average monthly stock returns for all the sectors used in this study and also the standard
deviation.

5.2 Pearson Correlation Matrix

Coming to correlation among the predictive variables for all the sectors, to
observe this correlation among all this independent variable I have prepared
Pearson correlation Matrix from May 2003 to May 2013 for every sector and
for each independent variables

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 Table.2
Banking Sector
Dividend.Price.Ratio PE.Ratio Size Market.to.Book.Ratio Payout.Ratio
Dividend.Price.Ratio 1 -0.7965 -0.1876 -0.7371 -0.1746
PE.Ratio -0.7965 1 0.2235736 0.7319 0.275
Size -0.1876 0.2235 1 0.2268 -0.3992
Market.to.Book.Ratio -0.7371 0.7319 0.2268349 1 0.12192339
Payout.Ratio -0.1746 0.275 -0.3992567 0.1219 1
Note :-This table shows the correlation between all the variables for Banking sector.
Table.3
General Industrials
Dividend.Price PE.Ratio Size Market.to.Book.Ratio Payout.Ratio
Dividend.Price 1 -0.3121946 -0.7324208 -0.1190192 0.7020803
PE.Ratio -0.3121946 1 0.2526798 0.1715212 -0.1207696
Size -0.7324208 0.2526798 1 -0.2570843 -0.7541131
Market.to.Book.Ratio -0.1190192 0.1715212 -0.2570843 1 0.4097802
Payout.Ratio 0.7020803 -0.1207696 -0.7541131 0.4097802 1
Note :- This table shows the correlation between all the variables for General Industrials.
Table.4
Industrial Engineering
Dividend.Price.Ratio PE.Ratio Size Market.to.Book.Ratio Payout.Ratio
Dividend.Price.Ratio 1 -0.5439804 -0.8359583 0.004464535 0.5860022
PE.Ratio -0.543980408 1 0.248454 0.288080558 -0.2707581
Size -0.835958327 0.248454 1 -0.154825759 -0.6504607
Market.to.Book.Ratio 0.004464535 0.2880806 -0.1548258 1 -0.2460164
Payout.Ratio 0.586002176 -0.2707581 -0.6504607 -0.246016406 1
Note :- This table shows the correlation between all the variables for Industrial Engineering.

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 Table.5 5
Software and Computer Services
Dividend.Price.Ratio PE.Ratio Size Market.to.Book.Ratio Payout.Ratio
Dividend.Price.Ratio 1 -0.2541287 -0.1269445 -0.3495384 0.1849232
PE.Ratio -0.2541287 1 0.3267063 -0.1372427 -0.3347966
Size -0.1269445 0.3267063 1 -0.6376264 -0.7559005
Market.to.Book.Ratio -0.3495384 -0.1372427 -0.6376264 1 0.7246725
Payout.Ratio 0.1849232 -0.3347966 -0.7559005 0.7246725 1
Note :- This table shows the correlation between all the variables for Software and Computer
Services.

These all table show high level of correlation among all the independent
variables used in this study, also these variables are statistically significant.

5.3 Regression Result

After examining the correlation between all the independent variables now I
can go for regression result. I have used OLS regression for this study, where
stock return is my Dependent variable (Y), and I have used five independent
variables namely, Dividend Price ratio, Price earnings ratio, Size, Market to
book ratio, and Payout ratio to examine the relationship between these
variables and stock returns for all the sectors from the period May 2003 to
May 2013.

Table.6Regression results for Variables

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 Sector Constant PE D/P Size MtB Payout Ratio R Squared Adj R Squared F-Statistics N
Banking Sector 0.055 0.348 0.840 0.036 0.838 0.053 0.050 0.009 1.222 121
[1.937359] [0.9434] [-0.202609][-2.121051] [-0.204389] [-1.956304]

General Industrials 0.013 0.202 0.000 0.129 0.208 0.431 0.17 0.14 4.768 121
[-2.518] [1.281] [3.837] [1.528] [1.265] [-0.789]

Industrial Engineering 0.446 0.012 0.051 0.975 0.390 0.969 0.14 0.11 3.832 121
[-0.764] [2.561] [1.974] [0.031] [0.862] [0.039]

Software and Computer Services 0.490 0.001 0.694 0.499 0.670 0.962 0.11 0.07 2.826 121
[-0.693] [3.607] [0.394] [-0.678] [0.427] [0.047]
Note :- In this table coefficients in parenthesis show the P values. Figures in Bracket show
the t-statistics value for each variabl. This table represents the result for average stock
returns, D/P, P/E, Size, MtB, Payout ratio for four sectors for the period of 2003 to 2013.
Table 6 shows the result of my regression test which constitutes four major
sectors in Indian market and five variables.

 Banking Sector
Starting with banking sector, Size is statistically significant with P value of
0.036, so according to the result Size has positive significant relationship
with stock return. So size or magnitude of the company has positive and
significant impact on stock return. So this results actually supporting the
results of PradoshSimlai(2009) as in his study on US market he found
positive relationship between Stock return and Size variable. So from this
result I can say that in Indian market Size is very important factor for
investors when they are investing in a stock from Banking Sector. This result
shows that Indian investors look for market value when investing in Banking
sector rather than other things.

Another Significant variable is payout ratio in case of banking sector, which

represents positive and statistically significant relationship among stock
returns and Payout ratio. Higher the Payout ratio better is for the earnings
from earning means when Payout ratio it indicates that company is paying

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dividend rather than retaining it. In banking sector significant payout ratio
shows that Investors can predict future stock returns using this variable, and
accordingly they could decide their strategies for investment in this
particular sector. Positive and significant payout ratio also indicates that
investors are more concern about dividend payout by banks while investing
in this sector, as this ratio represents how much dividend company is paying
and how much earnings company is retaining. Investors are looking for
Dividend earnings while investing in this sector.

Other variable like P/E ratio which shows positive but insignificant
relationship with stock return, According to Guler Aras and Mustafa Kemal
Yilmaz(2008)P/E ratio can predict the stock return for the period of 1 year in
four emerging markets, but markets which have been targeted in that study
are not big markets and those markets are not liquid like Indian market.
Indian market is also an developing market but size wise Indian market is
way bigger than those emerging markets targeted in that study. BSE which
is the 10th largest stock exchange in the world in terms of Market
capitalization, So results in Indian context is different. P/E ratio does not
seem to predict stock return in Indian stock market particularly in case of
banking sector. From the investor’s perspective, P/E ratio shows that
Investors are not looking for capital gain on banking stock rather they are
going for Long term investment and dividend earning is more important for
them than that of Capital gain. Market to book ratio which is also highly
insignificant in case of banking sector shows that, MtB cannot predict stock
returns in Banking sector, also Investors are not concern with book value of
the banking stock, Market value is more important factor for them while
investing in this sector.

 General Industrials
In case of General Industrials, Dividend price ratio is highly significant with t-
statistics value of 3.837, this shows positive and statistically significant

22 | P a g e
relationship between stock return and dividend price ratio. According to the
result, Dividend price ratio can predict the stock return for general industrials
stocks as there is positive and highly significant relationship between stock
return and this ratio, this findings are supporting the view of Robert H.
Litzenberger and Krishna Ramaswamy(1982) as in their study as well they
find significant relationship between stock return and dividend yield.
Dividend price ratio helps investor to know how much effective return he is
going to get on his investment in future, In this case positive and significant
D/P ratio shows that investors while investing in this sector are more likely
looking for dividends and returns on their investment through dividends.

Another significant variable in this sector is Size with t-statistics value

of1.528. It is significant and positive which shows positive and significant
relationship between stock return and Size. Size is the magnitude of the
company or market value of the company, Size is another important factor
for investors while investing in these stocks. Company size is total market
capitalization of the company and results shows that for investors Size is
very important factor.

But in this sector Payout ratio is not significant as well as Market to book
ratio. Price earnings ratio which is also insignificant in case of this sector.
This result represents that, Payout Ratio, Market to book ratio and price
earnings ratio have no significant relationship with stock return and cannot
predict stock return. But this result of Market to book ratio is contradictory to
the findings of Raj AggarwalTakatoHiraki and Ramesh P Rao(1992), in their
study on Japanese stock market they found positive and significant
relationship between price to book ratio and stock return, they have also
mentioned that investors can build their strategies according to their
findings. But in Indian market, particularly about General industrial sector
MtB ratio does not seem significant. Raj AggarwalTakatoHiraki and Ramesh P
Rao(1992) have considered the whole Japanese stock market, whereas my

23 | P a g e
result is for particular sector hence results could be different in case of Indian
context.

 Industrial Engineering
Industrial Engineering is next sector in my regression result. Price earnings
ratio for this sector is highly significant, Price earnings representthe
expectations of the investors regarding the earnings from the stock, high P/E
ratio represents that investors are expecting higher earnings growth.
According to the result there is positive and statistically significant
relationship between stock returns and price earnings ratio. So in case of this
sector Price earnings ratio can predict the future stock returns. Each industry
sectors have different growth prospects, and according to these prospects
investors invest their money in particular industry. This significant Price
earnings ratio shows that investor are looking for capital gain when they are
investing in the stocks from this sector of Industrial engineering.

This Industrial engineering sector has included with some of the major
companies in Indian stock market, which are giant in their particular field,
some of the companies from this sector are ABB, Bharat Forge, Bharat Heavy
electrical, Mahindra and Mahindra, Nelco, SKF India, Tata Motors and
Thermax. ABB is Zurich, Switzerland based multinational company operating
in robotics and mainly automation and power areas, It is one of the largest
engineering company in the world with presence in more than 100
companies. Price earnings ratio of ABB was consistently very high starting
from 14.60 in 2003, It was highest in 2011, whereas in 2008 due to recession
and bad market condition Price earnings ratio falls down as expected, In
recession investors become pessimistic about growth prospect of the
company and it had clearly reflected on company's Price earnings ratio in the
period of 2007 - 2008 where Price earnings ratio of this company had
hampered badly. But otherwise Price earnings ratio was consistently high
showing investors are expecting significantly high returns from the

24 | P a g e
company's stock. Bharat forge which is also in this sector, this is also another
Giant in the field of forging industry. Forbes has rated Bharat Forge as the
best forging company in Asia, Price earnings ratio for this company was
consistently high except in recession phase. Bharat heavy electrical is
government owned company and another big company in Indian stock
market, Tata Motors is another example from this industry with high Price
earnings ratio.

This consistent high price earnings ratio shows that investors are expecting
high returns from these stocks, this represents that investors are looking for
capital gain on their investments in this sector. Result for price earning from
my regression result is somehow supporting the findings of Guler Aras and
Mustafa Kemal Yilmaz(2008), because in their research also they found
significant price earnings ratio in case of most of the stock markets, where
P/E ratio is positively and statistically significant with stock return and can
predict the stock return.

Dividend price ratio is another significant variable in this sector. Result for
this sector shows positive and statistically significant relationship among
dividend price ratio and stock return, Dividend price ratio is another variable
which can predict the stock return for this particular sector. D/P is significant
with t-statistic value of 1.97, which show that investors can use this variable
as predictive variable for stock return, Price earnings ratio is another
predictive variable in case of this sector. D/P ratio represents how much
company pays out earnings as dividend each year relative to its share price.
Positive and significant dividend price ratio shows that, Investors are looking
for dividend earnings from the stocks in this sector, while investing in this
sector investors are more concern about dividends they will be getting from
their investments.

25 | P a g e
Overall in this sector investors are looking for capital gains as well as
dividend earnings while investing in this sector as Price earnings ratio and
Dividend price ratio both show positive and statistically significant
relationship with stock returns. Other three variables like Size, Market to
Book ratio and Payout ratio which are statistically insignificant in case of this
sectors shows that, there is not relationship among these variables and stock
return, hence MtB, Size and Payout ratio cannot predict stock return for this
particular sector. Insignificant MtB ratio shows that investors are not concern
about whether stock is overvalued or undervalued compared to its book
value. They are just looking for Capital gains and dividend earnings out of
their investment in this particular sector as P/E and D/P ratios are positive
and statistically significant. Size also insignificant and cannot predict stock
return for this sector, result is same in case of payout ratio for this sector.

 Software and Computer Services

Taking Software and Computer services Sector into consideration, only price
earnings ratio is the significant variable out of all five variables used in this
study. Price earnings ratio is significant with t-statistic value of 3.607, this
shows that only P/E ratio can predict the stock return for Software and
computer services sector. This significant P/E ratio shows that, investors are
just looking for capital gains from software stocks, they are just concern
about the earnings through the increase in the price of stock. While investing
in this sector investors are not concern about book value of the stock as
market to book ratio is insignificant, they are just concern about market
price of the stocks, hence stocks from this sectors are mostly inflated than
its book value. Dividend price ratio is insignificant and shows no relationship
with stock return,

Unlike industrial engineering in this sector dividend price ratio is insignificant

therefore investors are not concern about dividend earning in this sector,
they are looking for capital gain on their investment. As investors are looking

26 | P a g e
for capital gain most of the stocks from this sector are very volatile and show
sudden ups and downs in their prices. Stocks like Infosys, Wipro which are
highly efficient and flexible to new information and new events in the
market. Ups and downs of the prices of these stocks are totally depend on
the favorable and unfavorable information hitting stock market time to time.
Due to this approach of investors who are just looking for capital gain from
the stocks, these stock prices are very volatile. Dividend price ratio which is
highly insignificant in case of software industry which shows that, there is
not relationship between stock returns and D/P ratio for this sector, and
ultimately this D/P ratio cannot be used as predicable variable for stock
return or for predicting stock return. Dividend price ratio is used by investors
to assess how much returns they are getting in form of dividend from their
investment in that stock by comparing the returns to the actual stock price,
D/P ratio is nothing but comparing stock returns in the form of dividend to
the market price of the stock. From this ratio investors can actually evaluate
the returns they are getting out of their investment. My regression results
show insignificant D/P ratio and insignificant relationship among D/P and
stock return which means this variable cannot predict the stock returns for
Software sector.

This insignificant relationship between D/P and stock return also shows that
investors are not worried and concern about the returns or dividends while
investing in this particular sector, they are only looking for capital gains or
gains from increase in stock price as the price earnings ratio is significant.
Size, Market to book ratio, and Payout ratio all these variable seem
insignificant according to my regression result and show no relationship of
these variables with stock return, So in this software sector these variables
like MtB, Size, and Payout ratio cannot predict stock returns. From the
investors prospective as well, Investors don't look for Book value, size or
payout ratio of any company while investing their money in this sector and
findings regarding this three variables are not supporting the findings of Kee

27 | P a g e
Hong Bae, Jeong-Bon Kim(1998), the main reason for this contradictory
results could be different markets altogether, My study is focused on Indian
stock market and this particular result is only for one particular sector that is
Software and Computer services sector whereas Kee Hong Bae, Jeong-Bon
Kim(1998) have focused on Japanese stock market and that too they have
focused on whole market. Japanese market is developed stock market and is
way different than Indian stock market in case of regulations and governance
matter, hence this possibility cannot be neglected and hence result from one
sector of Indian stock market is different than Japanese stock market.

Overall, my results are supporting some previous studies in case of some

sectors and in case of some variables but not completely. This difference in
result is observed due to different phases each market is experiencing,
Indian market is emerging market and need to develop in many ways.
Developed markets are well regulated and well governed but in case of
emerging market these factors differ, Indian market is big and huge in terms
of market capitalization but they are many aspects which need to be
improved in Indian market like, Regulation, Governance mechanism and
many other regulatory aspects. Due to this differences results from Indian
stock market are somewhat different from other developed markets like
Japan, UK, and US.

Another aspect is Indian stock market is very efficient and flexible to new
information and new events in global market, you can observe immediate
effect of any unfavorable or favorable news or events on Indian stock
market. Major markets around the world like New York Stock Exchange,
American Stock Exchange, London stock exchange have significant impact
on Indian stock market, It shows fluctuation according to these major
markets so taking into consideration all these effects and impacts of global
markets it is very difficult to examine why exactly some results and findings
from this paper is not supporting other literatures and studies in finance

28 | P a g e
based on other market. Due to this sensitivity of the Stock market
sometimes it experiences bullish or bearish movements depending on
favorable or unfavorable information.

Satyam computer services scandal which actually did hamper a stock market
a lot that too in a period of global financial crisis. Due to this scandal
investors become more pessimistic and feel insecure about their investments
in the stock market and pulled out all of their money invested out of stock
market which cause major stock market crash and Sensex closed at 8,160.40
lowest close since 2nd November 2005. Satyam computers scandal was
biggest scandal in IT industry in India, On 7th January 2009 company's CEO
RamalingaRaju had resigned and confessed that he had manipulated the
accounts by $1.47 billion. The whole global and corporate community was
shattered because of this scandal and this scandal hampered Indian stock
market badly. Such unfavorable events make the stock market unstable and
therefore it is very difficult to find consistency in results for all the stock
exchanges around the world.

6. Conclusion

In this study I have observed the relationship between stock returns and five
different variables namely Dividend price ratio, Price earnings ratio, Size,
Market to Book ratio, and payout ratio. I have collected the total data sample
of 357 firms in total from four different sectors, I have observed this
relationship according to the sector. Paper also tried to examine the
investors choice and approach towards investment and how and what
variables do matter for them while investing in any particular stock.

According to the findings some variables are significant and show significant
positive relationship with stock return, on the other hand some variables

29 | P a g e
from some sectors are highly insignificant and show no relationship with
stock return. In case of banking sector Size and payout ratio are positive and
significant which show positive and significant relationship between stock
return and these variables. Investors who are investing in banking sector
would be concern about these variables while investing in this particular
sector, other variables like, D/P, MtB, and P/E ratio are insignificant and do
not show any significant relationship with stock return. I have also examined
the general industrial sector, this sector constitutes all the major
manufacturing industries in India like, 3M India, Sharp Industries. Result for
this sector shows that D/P ratio is highly significant and have positive
significant relationship with stock return, which represents that D/P ratio can
actually predict the stock returns for the stocks from this sectors. Another
variable which is significant for this particular sector is Size, which is also
shows positive significant relationship with stock return. Investors while
investing in this general industrial sector would be looking for Dividend
earning and the returns from the stocks in which they have invested, another
important factor for investors would be Size while investing in this Sector,
other variables like P/E ratio, MtB ratio, and Payout ratio for General
Industrials are not significant and therefore show no relationship with stock
return, this result also shows that investors while investing in this sector are
not concern about capital gain or increase in stock price they are looking for
Dividend and want to hold the stock for long term period, insignificant MtB
ratio shows that investors are not concern about book value of the stocks
particularly for this sector. These finding for General industrial sector are
supporting the view of Robert H. Litzenberger and Krishna
Ramaswamy(1982).

In case of Industrial engineering sector, P/E and D/P ratios are positive and
significant which show positive and significant relationship with stock return,
these two variables can predict the stock return for this sector. By using
these variables investors can decide their investment strategies. Results

30 | P a g e
regarding Price earnings ratio for Industrial Engineering are supporting the
results of Guler Aras and Mustafa Kemal Yilmaz(2008), in their study as well
they found significant relationship between P/E ratio and Stock return.

According to the results of Software and Computer services sector I found

only Price earnings ratio as a significant variable out of five variables used.
This is mainly because IT sector is continuously and rapidly growing which
has increased the expectations of investors regarding their investments and
therefore price earnings ratio is positively significant, high P/E ratio shows
that investors are expectin higher growth from stock and ultimately capital
gain. From this result it is clear that, investors who are investing in software
industry are investing money in stock just to take the advantage of stock
price increase.

Overall my study contributes to the corporate finance literature by

examining the relationship between all five variables and stock return of four
different sectors of Indian stock market. I have also examined the investors
choices and approaches towards investing in these four sectors. In case of
some sectors like Software and computer services sector and Industrial
Engineering sector investors are looking for capital gain and only concern
about the increase in a price of stock, which is supported by my findings
regarding P/E ratio, where In both the sectors namely Software and Industrial
Engineering P/E ratio is positive and statistically significant. But in Banking
sector investors are concern about magnitude of the company that is Size
variable hence, Size variable can predict stock return for banking industry.
For General Industrial D/P ratio is significant variable which can predict stock
return for this industry and also investors which are investing in this industry
are concern about dividend and returns from their investments. In this study
I have analyzed five variables and four different major sectors of Indian stock
market. Some of the findings from this paper are supporting literature and
some findings are not supporting. In these four sectors, for each sectors

31 | P a g e
some variables Which I found significant and some insignificant which do not
have any relationship with stock return.

Further research could be done on the same topic by adding some more
variables and by covering some more data period. Further research study
could include some new variables like Leverage, book to market ratio etc. In
this paper I have not covered the impact of other major stock markets on
Indian stock market in detail, so in further research this point could be of
more focus and one can analyze and examine the detail effect of other stock
exchanges on Indian stock market. This paper also not covered the impact of
regional and local events on stock market such as scandals, changes in
Interest rates, Changes in Government policies etc which could be covered in
further research. Such events news and new information make the stock
market unstable for some time and because of such instabilities sometimes
research result could be bias and cannot evaluate and find the actual results
and findings.

32 | P a g e
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Appendix

Table. 7 Regression Result For Banking Sector

36 | P a g e
Banking Sector

Dependent Variable: STOCK_RETURN

Method: Least Squares
Date: 06/07/13 Time: 19:41
Sample: 2003M05 2013M05
Included observations: 121

Variable Coeffi cient Std. Error t-Statistic Prob.

SIZE -4.13E-10 1.95E-10 -2.121051 0.0361

PE_RATIO 5.66E-03 6.00E-03 0.9434 0.3475
PAYOUT_RATIO -1.96E-02 1.00E-02 -1.956304 0.0529
MARKET_TO_BOOK_RATIO
-1.32E-02 6.48E-02 -0.204389 0.8384
DIVIDEND_PRICE_RATIO
-4.42E-01 2.18E+00 -2.03E-01 0.8398
C 4.14E-01 2.14E-01 1.937359 0.0552

R-squared 0.050446 Mean dependent var 0.053825

Adjusted R-squared0.009161 S.D. dependent var 0.118069
S.E. of regression 1.18E-01 Akaike info criterion -1.395982
Sum squared resid 1.59E+00 Schwarz criterion -1.257348
Log likelihood 90.45692 Hannan-Quinn criter. -1.339678
F-statistic 1.22E+00 Durbin-Watson stat 1.807331
Prob(F-statistic) 0.303345

Table. 8 Regression Result for General Industrials

37 | P a g e
General Industrials

Dependent Variable: STOCK_RETURN

Method: Least Squares
Date: 06/06/13 Time: 14:57
Sample: 2003M05 2013M05
Included observations: 121

Variable Coeffi cient Std. Error t-Statistic Prob.

SIZE 7.86E-08 5.14E-08 1.528731 0.1291

PE_RATIO 0.003659 0.002854 1.281938 0.2024
PAYOUT_RATIO -0.010273 0.01301 -0.789656 0.4314
MARKET_TO_BOOK_RATIO
0.126357 0.099817 1.265887 0.2081
DIVIDEND_PRICE 15.48725 4.036018 3.83726 0.0002
C -0.786248 0.312132 -2.518957 0.0131

R-squared 0.171712 Mean dependent var 0.114726

Adjusted R-squared0.135699 S.D. dependent var 0.432677
S.E. of regression 0.40225 Akaike info criterion 1.064828
Sum squared resid 18.60756 Schwarz criterion 1.203462
Log likelihood -58.4221 Hannan-Quinn criter. 1.121133
F-statistic 4.768116 Durbin-Watson stat 1.109891
Prob(F-statistic) 0.000537

38 | P a g e
 Table 9 Regression Result for Industrial Engineering

Industrial Engineering

Dependent Variable: STOCK_RETURNS

Method: Least Squares
Date: 06/06/13 Time: 15:03
Sample: 2003M05 2013M05
Included observations: 121

Variable Coeffi cient Std. Error t-Statistic Prob.

SIZE 1.72E-10 5.44E-09 0.031714 0.9748

PE_RATIO 0.00484 0.00189 2.561004 0.0117
PAYOUT_RATIO 0.000368 0.009346 0.039401 0.9686
MARKET_TO_BOOK_RATIO
0.013978 0.016211 0.862236 0.3904
DIVIDEND_PRICE_RATIO
2.851001 1.443784 1.974673 0.0507
C -0.205249 0.26841 -0.764684 0.446

R-squared 0.142805 Mean dependent var 0.099137

Adjusted R-squared 0.105536 S.D. dependent var 0.165102
S.E. of regression 0.156147 Akaike info criterion -0.827716
Sum squared resid2.803935 Schwarz criterion -0.689082
Log likelihood 56.07684 Hannan-Quinn criter. -0.771412
F-statistic 3.83171 Durbin-Watson stat 1.731668
Prob(F-statistic) 0.003013

39 | P a g e
 Table 10 Regression Result for Software and
Computer Services

Software and Computer Services

Dependent Variable: STOCK_RETURN

Method: Least Squares
Date: 06/06/13 Time: 15:11
Sample: 2003M05 2013M05
Included observations: 121

Variable Coeffi cient Std. Error t-Statistic Prob.

SIZE -2.53E-09 3.73E-09 -0.678082 0.4991

PE_RATIO 0.004034 0.001118 3.607497 0.0005
PAYOUT_RATIO 0.00049 0.010307 0.047496 0.9622
MARKET_TO_BOOK_RATIO
0.018982 0.044363 0.427871 0.6695
DIVIDEND_PRICE_RATIO
7.45E-01 1.89E+00 0.394984 0.6936
C -0.127423 0.183819 -0.6932 0.4896

R-squared 0.109412 Mean dependent var 0.087699

Adjusted R-squared0.070691 S.D. dependent var 0.245729
S.E. of regression0.236884 Akaike info criterion 0.005823
Sum squared resid 6.453116 Schwarz criterion 0.144457
Log likelihood 5.647695 Hannan-Quinn criter. 0.062128
F-statistic 2.825633 Durbin-Watson stat 1.45394
Prob(F-statistic) 0.019143

40 | P a g e