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INNOVATIVE JOURNAL OF BUSINESS AND MANAGEMENT
Journal homepage:http://www.innovativejournal.in/index.php/ijbm
ANALYZING THE PERFORMANCE OF HIGH AND LOW BOOK-TO-MARKET RATIO
FIRMS WITH SPECIFIC REFERENCE TO INDIAN IT, PHARMACY AND BANKING
STOCKS
Venkatesh. C. K1*, Madhu Tyagi2, Ganesh. L3
1Research
Scholar, IGNOU, Maidan Ghari, New Delhi
of Management, IGNOU, Madain Ghari, New Delhi.
3Institute of Management, Christ University, Hosur Road, Bangalore-560 030.
2School
ARTICLE INFO
Corresponding Author:
Venkatesh. C. K
Research Scholar, IGNOU, Maidan
Ghari, New Delhi
[email protected]
Key Words Fundamental analysis,
Financial Statements, Return on
assets, Book to market ratio.
ABSTRACT
This paper tries to explore the Financial Performance of High and
Low Book-to-Market ratio firms with specific reference to Indian IT,
Pharmacy and Banking Stocks. Previous Literature has documented that
all High Book-to-Market ratio firms are financially distressed. It is also
been proved that high Book-to-Market stocks are those with poor
historical performance and have not received enough attention from the
investors. Investors tend to be over pessimistic about the future
performance of these stocks. Envisaging all these, the current research
tries to prove all documented facts in the Indian Stock Market with
specific reference to mentioned stocks. In this research work a simple
financial score is designed to capture short term changes in firm’s
Profitability, Solvency, Liquidity, Earnings Stability and Accounting
Conservatism. For this purpose Historical Financial Information is
derived from various financial statements. Using Historical Financial
Information is a method adopted in fundamental analysis which is helpful
in predicting future stock returns and for explaining the momentum
phenomenon in stock prices. The goal of this paper is to show that
investors can create a stronger value portfolio by using simple historical
financial performance and identify winning and losing stocks.
©2013, IJBM, All Right Reserved
INTRODUCTION
Financial Statements
A Financial Statement is a collection of data
organized according to logical and consistent accounting
procedures. Its purpose is to convey an understanding of
some financial aspects of a business firm. It may show a
position at a moment in time, convey profit status at
another point in time or may show inflow and outflow of
cash/funds. Financial statements are the outcome of
summarizing process of accounting.
Thus, Financial Statements generally refers to the two
statements: ( i) the position statement or the balance sheet
and (ii) the income statement or the profit and loss
account. These statements are used to convey to
management and other interested outsiders the
Profitability, Solvency and Financial Position of a firm.
Fundamental Analysis
Fundamental analysis is a method of finding out
the future price of a stock which an investor wishes to buy.
It relates to the examination of the intrinsic worth of a
company to find out whether the current market price is
fair or not, whether it is overpriced or under priced. It
believes that analyzing the economy, strategy,
40
management, product, financial status and other related
information will help to choose shares that will out
perform the market and provide consistent gains to the
investor. It is the examination of the underlying forces that
affect the interest of the economy, industrial sectors and
companies. It tries to forecast the future movement of the
capital market using signals from the Economy, Industry
and Company. It requires an examination of the market
from a broader perspective. The presumption behind
fundamental analysis is that a thriving economy fosters
industrial growth which leads to development of
companies. Estimate of real worth of a stock is made by
considering the earning potential of the company which
depends on investment environment and factors relating to
specific industry, competitiveness, quality of management,
operational efficiency, profitability, capital structure and
dividend policy.
Review of Literature
The origin of Fundamental analysis for the share
price valuation can be dated back to Graham and Dodd
(1934) in which the authors have argued the importance of
the fundamental factors in share price valuation.
Analyzing the Performance of High and Low Book-to-Market Ratio Firms with specific reference to Indian IT,
Pharmacy and Banking Stocks
Theoretically, the value of a company, hence its share price, Statement of the Problem
is the sum of the present value of future cash flows
Analyzing the stock returns is a matter to
discounted by the risk adjusted discount rate. This contemplate among the equity researchers. To analyze the
conceptual valuation frame work is the spirit of the predictability of stock returns the researchers use various
renowned dividend discount model developed by Gordon tools and techniques which might not give assured results.
(1962). However, the dividend discount model valuation Therefore, to facilitate such prediction Academicians as
involves the forecast of future dividend payment which is well as the Equity Researchers have developed several
difficult due to the changes in firm’s dividend policy. Thus, innovative techniques and two such techniques are F_Score
the subsequent studies along this line of literature searched and G_Score as developed by Piotroski (2000) and
for the cash flow that is unaffected by the dividend policy Mohanram (2005) respectively. The current research work
and can be obtained from the financial statements.
emphasizes on the work of these two authors in the Indian
Ou and Penman (1989) use financial statement analysis of context. These two techniques is applied to the Indian
income statement and balance sheet ratios to forecast Banking, Pharmacy and Information Technology stocks and
future earnings. The primary motivation for this research is the process is evaluated as suggested by Piotroski (2000)
to identify mispriced securities. However, these authors and Mohanram (2005).
demonstrate that the information in the earnings
In addition to this, the current research tries to
prediction signals is helpful in generating abnormal stock examine the returns variation among each group of high
returns.
and low book-to-market ratio stocks by using financial
Fama and French (1992) show that value stocks (high statement analysis.
book/market) significantly outperform growth stocks (low Objective of the study:
book/market). The average return of the highest

Constructing F_Score and G_Score to
book/market decile is reported go be one percent per
evaluate Information Technology, Pharmacy and
month higher than the average return for the lowest
Banking firms in the Indian context.
book/market decile.
Specific Objectives:
Jagadeesh and Titman (1993) document that over The objectives of the study can be concluded by
a horizon of three to twelve months, past winners on an • Usage of various fundamental signals to measure Five
average continue to outperform past losers by about one
Areas of Firm’s Financial Status: Profitability, Solvency,
percent per month.
Operating Efficiency, Earnings Stability and Accounting
Lev and Thiagarajan (1993) use conceptual arguments to
Conservatism
study their ratios. They demonstrate that the earnings • Examining returns variation among each group of high
prediction signals in variables like growth in accounts
and low book-to-market ratios stocks by using
receivables relative to sales growth and gross margin rate
financial statement analysis ( this objective is set as a
are incrementally associated with contemporaneous stock
part of Fundamental Analysis)
returns and are significant in predicting future earnings.
• Classification of companies as “Good” or “Bad”
Joseph. D. Piotroski (2000) examines whether a
depending on the signal’s implications for future prices
simple accounting based Fundamental Analysis strategy,
and profitability.
when applied to a broad portfolio of high Book to Market • Constructing aggregate signal to measure the overall
firms, can shift the distribution of returns earned by an
strength of the firm’s financial position.
investor. The research shows that the mean returns earned Methodology
by a high Book to Market investor can be increased by at The current research work is contemplated after
least 7.5% annually through the selection of financially thoroughly reviewing the above mentioned literature. For
strong high Book to Market firms.
the purpose of this work firms are broadly categorized as
Pascal Nguyen, (2003) constructs a simple Information Technology, Pharmacy and Banking. At the
financial score designed to capture short term changes in first instance Book-to-Market ratio is calculated to identify
firm operating efficiency, profitability and financial policy. firm’s having High/Low Book-to-Market ratio. After this a
The scores exhibit a strong correlation with market comprehensive F_SCORE/G_SCORE was constructed for
adjusted returns in the Current fiscal period and the same those firms having High/Low book-to-market ratio. Firms
continues in the following period also.
having highest F_SCORE/G_SCORE were given the first rank
Partha.S.Mohanram (2005) combines traditional followed by those having lower F_SCORE/ G_CORE. For
fundamentals, such as earnings and cash flows, with these firms Stock Returns, Earnings per Share and Price
measures tailored for growth firms, such as earnings Earning were ascertained for ten years. Later top 10 and
stability, growth stability and intensity of research and bottom 10 firms were chosen for analysis. The period of
development, capital expenditure and advertising, to create study is 01st April 2001 to 31st March 2010.
an index called – GSCORE. A long–short strategy based on An insight into F_SCORE
GSCORE earns significant excess returns, though most of F_SCORE is a composite indicator which incorporates
the returns come from the short side. High GSCORE firms various fundamental aspects of the firm and it is
have greater market reaction and analyst forecast surprises constructed to examine the future performance of the firm.
with respect to future earnings announcements. Further, The
concept
of
F_SCORE
was
developed
the results are in consistent with a risk based explanation JOSEPH.D.PIOTROSKI, Professor, The University of Chicago,
as returns are positive in most years, and firms with lower Graduate School of Business, in the year 2000. The goal of
risk earn higher returns. Finally, a contextual approach this research work is to show that investors can create
towards fundamental analysis works best, with traditional stronger value portfolios by using simple historical
analysis appropriate for high Book to Market stocks and financial performance.
growth oriented fundamental analysis appropriate for low Professor Piotroski identifies three broad heads to measure
Book to Market stocks.
the financial performance of a company which are
41
Analyzing the Performance of High and Low Book-to-Market Ratio Firms with specific reference to Indian IT,
Pharmacy and Banking Stocks
identified as Financial Performance Signals. They are, GSCORE is also constructed using the eight fundamentals as
Profitability, Solvency and Operating Efficiency variables.
laid down by Piotroski (2000), these signals are related to
Thus, the final score is represented as follows;
firm’s Profitability, Earnings stability, Sales stability and
FSCORE=
Accounting Conservatism. GSCORE emphasizes on the
ROA+AROA+CFO+ACCRUAL+DMARGIN+DTURN+DLEVER+
firm’s future performance and accounts for its growth
DLIQUID+EQOFF
factor. The GSCORE is constructed by three categories of
An insight into G_Score
eight signals which include Return on Assets (ROA), Cash
The investment strategy based on the FSCORE does not suit Flow from Operations (CFO) and Accrual. The definition of
for the low book-to-market ratio stocks as documented by these variables is identical to those used in FSCORE but
Mohanram (2005).
Mohanram further extended the with the difference in assigning indicator values. These
FSCORE measurement to examine the fundamentals for the profitability related variables are assigned a value of one if
low book-to-market stocks. He argued that the financial they are larger than that of the industry median, and zero
statement analysis using FSCORE is not appropriate for the otherwise.
low book-to-market stocks because it failed to consider the Similar, to the construction of the FSCORE, the composite
growth fundamentals of these firms. Growth firms are GSCORE is the sum of these eight fundamental signals.
usually those with stable earnings and sales growth, larger GSCORE=ROA1+CFO1+ACCRUAL+ 𝜎 N1+ 𝜎 SG+RDINT+ADINT+
Research and Development expenses and capital CAPINT
A higher F_Score/G_Score indicate more good fundamental
expenditure, and more analysts following.
Mohanram (2005) constructed GSCORE measurement signals of a firm and thus better financial health for the
which accounts for the financial variables that concern the value stocks/growth stocks. A lower F_Score/G_Score
future performance of the firms. The results of this indicate less good fundamental signals of a firm resulting in
research showed that for the low book-to-market stocks, lesser financial health. Mohanram (2005) showed that an
high GSCORE firms are more likely to beat the earnings investment strategy with long position in high GSCORE
forecasts and thus earn higher excess return than the low stock and short position in the low GSCORE stocks generate
excess returns up to two years after the portfolio
GSCORE firms.
formation.
Analysis and Interpretation
Table 1showing Descriptive Statistics of firms involved in high and low F and G_Score
Top F
Bottom F
Top G
Bottom G
Average
ratio
1.59
4.97
0.49107
0.580191
BM
Average Returns
Average Assets
Average EPS
Average PE ratio
366.65
6.67
630.24
20.43
19871.59
669.38
382593.4
5310.68
51.22
-4.37
27.71
-1.82
13.44
32.32
19.74
52.47
Above table compares the results of descriptive statistics
pertaining to analysis of Top and Bottom F and G_Score
firms. For this purpose of analysis common variables not
relating to the construction of score is considered. As it is
evident from the table, Top and Bottom F_Score firms are
having higher BM ratio compared to the firms under
G_Score. As proved by Piotroski (2000) F_Score is more
suitable for firms having high BM ratio and Mohanram
(2005) endorses the applicability of G_Score for firms with
low BM ratio.
Average returns given by top G_Score firms is
almost double than the top F_Score firms, one interesting
observation to note is that EPS given by high F_Score firms
is almost double than the top G_Score firms. In the long run
high F_Score firms have created wealth for their investors.
The Mean of the BM ratio are 1.59 (4.97) and
0.49107 (0.580191) for the value and growth stocks having
high and low scores respectively. The growth stocks has
larger asset base than the value stocks. The average assets
of high/low score value stocks 19871.59 (669.38) and
382593.4 (5310.68) with that of high/low score growths
stocks. It is evident that growth stocks has larger asset
base. Even low score growth stocks are having a healthy
asset base than the low score value stocks. The sales and
sales growth for the growth stocks are higher than those of
the value stocks for the entire sample. This confirms the
fact that growth firms grow at a faster rate than the other
firms. The main contribution to the sales growth of these
firms is the Research and Development intensity and the
nature of investments these firms make into Research and
42
Average No. of
trades
132762.71
9582.08
4383417
31222.73
Average PAT
217.77
-38.84
512.22
12.38
Development activities. Because of this reason there would
be a larger future potential growth opportunities for these
firms.
Consistent with the previous findings in Piotroski
(2000) and Mohanram (2005), future performance of the
stock returns are positively correlated to the firm’s
financial health. It is been noted in the current research
that fundamental scores and future returns are positively
correlated with F and G_Score firms, for a study period of
ten years. The correlation results of F_Score firms are
0.06273 and G_Score 0.98457.
Lakonishock, Shleifer and Vishny (1994) argued
from the behavioral aspects that high book-to-market
stocks are those with poor historical performance and have
not enough attention from the investors. Investors tend to
be over pessimistic about the future performance of these
stocks and higher future returns are expected when the
mispricing is corrected. To validate this statement in the
current research Average Number of Trades of all the
companies were compared with one another. It is very
evident from the analysis that firms with high G_Score are
associated with high number of trades. This indicates that
there is huge investor following for these company shares,
To conclude this analysis between F and G_Score firms, PE
of these firms were considered and from the analysis it is
concluded that high F_Score are having lower PE compared
to the high G_Score firms which naturally indicates the
ability of high F_Score firms in earning higher returns to its
share holders in terms of maximizing the Earnings per
share. The PE of high F_Score firms is recorded at 13.44 as
Analyzing the Performance of High and Low Book-to-Market Ratio Firms with specific reference to Indian IT,
Pharmacy and Banking Stocks
compared to 19.74 for high G_Score firms. The accounted individual share holders. All these results are in consistent
EPS is Rs.51.22 for high F_Score firms and 27.71 for the with the previous literature, which includes Fama and
firms with high G_Score. As specified in the beginning of French (1992), Piotroski (2000) and Mohanram (2005),
this section value stocks have out performed the growth Dr.Cheng Few Lee and Wei-Kang Shih (2009).
stocks in terms of maximizing Earnings per share to the
Examining Returns Variation among each group of high and low book-to-market stocks by using Financial
Statement Analysis
Table2 Showing Year-wise high and low book-to-market stocks by using Financial Statement Analysis
Year
MKT.
Returns of z-value
of Returns of z-value
of Returns
z-value
of
RET.
High
Returns of High G_Score Returns of of
low Returns
of
F_Score
High F_Score
High G_Score F_Score
Low F_Score
C1
C2
C3
C4
C5
C6
C7
C8
2001
-17.87
13.22
-0.57
38.09
0.03
-11.41
-0.04
2002
3.52
9.48
-0.66
14.56
-0.48
-28.22
-1.36
2003
72.89
110.67
1.61
66.16
0.65
-10.54
0.03
2004
13.08
21.39
-0.39
46.98
0.23
-7.39
0.28
2005
42.33
44.34
0.12
24.12
-0.28
-22.89
-0.94
2006
46.70
38.20
-0.01
30.63
-0.13
-16.02
-0.40
2007
47.15
76.59
0.84
47.26
0.23
4.67
1.23
2008
-52.45
-49.60
-1.98
-53.08
-1.97
-25.03
-1.11
2009
81.03
80.63
0.93
129.84
2.04
11.01
1.73
2010
17.43
43.25
0.10
22.12
-0.32
-3.82
0.56
Mean
25.81
38.81
0
36.68
0
-10.96
0
S.D
41.08
44.75
1
45.60
1
12.71
1
As observed from the above table, the Z-value of Returns of
High F_Score for the year 2001 is -0.57, standard deviation
is below the mean, while the Z-value of high G_Score is 0.03
Standard Deviation is above the mean. This indicates that
deviation is more than the mean with reference to high
G_Score firms as compared to high F_Score firms. The
negative z-value indicates that F_Score return of that
particular period is lesser the mean F_Score and positive zvalue indicates the F_Score return is higher than the mean.
Likewise, z-values of returns of high F_Score and high
G_Score across years (from 2002 to 2010) show a similar
pattern of negative and positive z-values with not much of a
variation. However, in few years such as 2003, 2007 and
2010 F_Score is showing better result than G_Score.
One Striking observation made from the above analysis is
that, whenever, the market returns are falling, the returns
of F and G_Score firms are also falling in tune with the
market. For all those years Market Returns as well as Firm
Returns are achieving negative Z value.
On the other hand, with respect to low F_Score and
G_Score return, it is seen that negative z-values of low
G_Score are higher than that of low F_Score. Interestingly,
in most of the years, both G_Score and F_Score are having
negative z-values indicating lesser than overall mean. This
clearly indicates the inability of low score firms in earning
returns to the share holders. As like the high F_Score and
G_Score, not much variation is observed between low F and
G_Score.
Return of
Low
G_Score
C9
-32.11
-10.77
2.75
-3.701
-6.34
16.64
38.98
-9.33
18.97
13.73
2.88
19.88
z-value of returns of
low G_Score
C10
-1.76
-0.69
-0.01
-0.33
-0.46
0.69
1.82
-0.61
0.81
0.55
0
1
consistent with the evidence as shown by Piotroski (2000)
and Mohanram (2005).
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CONCLUSION
At the bottom line it is concluded that high G_Score
firms are leading the race in augmenting the returns. Over a
period of 10 years high G_Score firms have given almost
double the returns of their counterpart the high F_Score
firms. One more important observation to note is that, all
high G_Score firms are getting the maximum attention from
the investors and investing community is behind these
stocks to speculate. From this it is evident that the firms
with low Book-to-Market ratio are getting the investor’s
attention towards them. All the above results are in
43