Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 1 Impact of Earnings per share on Market Value of an equity share: An Empirical study in Indian Capital Market Dr. Pushpa Bhatt, Sumangala JK Department of Commerce, Bangalore University, India pushpa_bhatt12@rediffmail.com; sumangalajkashok@gmail.com Abstract Equity valuation is a central question which the academicians and researchers in the field of Capital markets are trying to address through different angles. At the same time, the practitioners in the field of stock trading have been working through different clues. Use of accounting information for equity valuation is a field of research which has seen a lot of activities. In the recent past this field made seminal contribution with the publication of Ball and Brown (1968). A number of accounting variables have been used to explain equity value and equity return. Earning is an important variable affecting the market value of equity share. Once a successful company starts building up reserves it will also look for expanding its scale of operations and thus increase its earnings. Once a company starts earning attractive sum, the equity share will have more and more demand which will result in increase in market value of the equity. A lot of research in this area has taken place internationally especially with the data of USA. An attempt is made in this paper to study the impact of Earnings per share (EPS) on the market value of an equity share in the Indian context. The study is based on data of 50 companies over a period of 5 years. The 50 companies that have been selected are the first 50 companies in the list of India s most valuable companies as per the Business Today Survey of 2010. Based on our research, we conclude that EPS impacts the market value of an equity share in the Indian context.
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 2 Key Words: Earnings per share, Market value of Equity shares, Cross-sectional data, Time series data Introduction Equity valuation is a central question which the academicians and researchers in the field of capital markets are trying to address through different angles. At the same time, the practitioners in the field of stock trading have been working through different clues. Use of accounting information for equity valuation is a field of research which has seen a lot of activities. As described by Kothari (2001) in the recent past this field made seminal contribution with the publication of Ball and Brown (1968). The literature has grown rapidly with over 1000 publications in leading International academic Accounting and Finance journals in the past three decades. A number of accounting variables have been used to explain equity value and equity return. Book value, profitability in many forms, operating assets, earning, earning per share (EPS), residual value, growth in earnings per share, growth in profitability, growth of the company measured in different ways, dividend per share, growth in dividend per share, real option to grow, real option to abandon are some of the variables used to explain equity valuation. Earning is an important variable affecting the market value of equity share. Company producing and selling goods and services useful to citizens in a society and earning revenue covering its cost of production adds to its reserve and build up the same. Once a successful company starts building up reserves it will also look for expanding its scale of operations and thus increase its
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 3 earnings. Once a company starts earning attractive sum, the equity share will have more and more demand which will result in increase in market value of the equity. Earnings after interest, depreciation and tax belongs to the equity shareholders. Earnings per share is computed by dividing earnings after interest, the depreciation and tax by total number of out standing shares. Dividend may be distributed out of these earnings; whether it is distributed as dividend to shareholders or not, it belongs to the shareholders. Hence earning per share is a measure which the stock brokers and investors will watch carefully and consider it while deciding the market value of the equity share. In the above discussion, we have considered the effect of increase in earnings per share. The reverse will happen if the EPS falls down. From the above discussion it is clear that EPS affects the market value of equity share. Literature review reveals the same. Review of Literature Ohlson (1995) discusses the role of earning per share and its role in security valuation.. Ohlson (1995) discusses the role of earning, book value and dividends in equity valuation. Collins (1999) discusses the effect of negative earning on equity valuation. Dechow (1999) studies the effect of residual income and the equity valuation. Collins and Kothari (1989) concentrate on the stock price change associated with a given unexpected earnings change. It is based on cross-sectional inter-temporal data. Collins, Pincus, and Xier (1989) study the role of book value of equity in the equity valuation. Dechow (1999) discuss the role of residual value on equity valuation. Miller and Modigliani (1961) studied the effect of dividend policy and the growth of the company on equity valuation.
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 4 Dechow (1998) attempts to establish the statistical relationship with equity value, earnings and book value. Collins and Kothari (1989) tries to establish the leading relationship between stock returns, change in EPS and firmsize. Zhang and Chen (2007) discuss to establish relationship between equity value, earnings yield, change in profitability, change in capital investment, change in growth opportunity and change in discount rate. In this article equity value is dependent variable, remaining variables are independent variables. Research at the international level indicates that EPS does impact equity market value. In the Indian context, there is no research to establish the relationship between EPS and equity market value. Hence, the present paper aims at finding out whether EPS impacts equity market value in the Indian context. If it affects, the next question is what is the underling relationship? Objective of this Research In the above discussion, we have seen that many accounting variables impact market value of an equity share, as per research in international level. Earnings per share are an important variable affecting equity market value. The specific objectives of this research is o To see whether EPS impacts the equity market value, in the Indian context. If so, to find out the relationship between EPS and market value. We set the following hypothesis. o Ho: EPS positively impacts equity market value
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 5 Conceptual basis for the study Market value of an equity share: The market value of an equity share, as per the fundamental analysis broadly depends on three factors as follows: Economy factors Industry factors Company factors Economy factors include factors like GDP growth, favorable government policy, favorable agriculture production (if applicable), favorable industrial production and many more such factors. Industry factors relate to the factors relating to the industry to which the company in question belongs. It includes the phase of industry life cycle, competition within the industry and such other related factors. Company factors can be classified as financial and nonfinancial factors. But it is clear that nonfinancial factors can be translated into expected future financial factors. When it comes to financial factors, we have already given a list of accounting variables affecting market value of an equity share apart from earnings.
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 6 Research Methodology Operational Definition Earnings per share (EPS): The revenue earned by a company after meeting cost of production, then interest, depreciation and tax belongs to the equity share holders. This earnings divided by the number of outstanding equity shares is referred to as EPS. Data We use the data available in capital line database. We use the top 50 companies in the ranking of companies by market value as listed by Business To-day survey for 2010. We exclude banking and other finance companies from the sample. We consider the average closing price of equity market value of the selected companies. Market value of the equity share is the arithmetic mean of the closing price of the equity share for one month after the financial year end for the company. We normalize it by dividing the equity market value by face value of the company s equity. Then consider EPS value (adjusted value whenever applicable) for the sample companies and normalize it by dividing EPS by face value of equity share. We have collected data about EPS and market value of equity share of 50 companies for 5 years from 2006-07 to 2010-2011.
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 7 Findings Descriptive Statistics We have the following descriptive statistics regarding the variables of the present study. Table 1 Market value of equity share Year Arithmetic Mean Median Std deviation 2006-07 170.80 119.37 165.66 2007-08 156.41 103.95 140.06 2008-09 69.33 41.25 79.18 2009-10 117.68 86.75 100.86 2010-11 90.01 61.20 86.35 Table 1 gives the details of arithmetic mean, median and standard deviation of market value of equity of the sample companies of all the 5 years under study. The mean market value has fallen over the year from 2006-07 to 2008-09. It is lowest in the year 2008-09. It has picked up in the year 2009-10, but has declined in 2010-11. This behavior is understandable, since the year 2008-09 there was global financial crisis and later years have seen erratic recovery process.
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 8 Table 2 Earnings per Share Year Arithmetic Mean Median Std deviation 2006-07 6.46 4.70 7.17 2007-08 4.97 3.55 4.44 2008-09 5.17 3.75 4.50 2009-10 4.57 3.12 4.40 2010-11 2.84 2.17 2.33 Table 2 gives details of arithmetic mean, median and standard deviation of earnings per share for 50 sample companies. EPS has been highest in the year 2006-07 and it is lowest in the year 2010-11. It does not show any pattern in the intermediate years. Table 3 Correlation Coefficient between Market Value of Equity and EPS Year Correlation coefficient 2006-07 0.70 2007-08 0.82 2008-09 0.65 2009-10 0.44 2010-11 0.70
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 9 Table 3 describes the correlation co-efficient between market value of equity and EPS for 50 sample companies for 5 years under study. The correlation coefficients are all significant at 5% level. This indicates that there could be a positive relationship between EPS and market value of an equity share. Empirical Analysis We proceed to perform further detailed analysis. Table 4 Regression analysis between Market Value and EPS Year Std. Error of estimate R 2 p-values 2006-07 9.64 48.25% 0.000 2007-08 11.06 18.15% 0.000 2008-09 8.49 42.60% 0.000 2009-10 12.76 67.34% 0.000 2010-11 13.33 49.16% 0.000 AM of R 2 = 45.16% Following is the summary of the regression analysis carried out every year from the year 2006-07 to 2010-11. The R 2 ranges of 18.15% at the lowest level to 67.34% at the highest level for all the 5 years, the regressions are significant. The arithmetic mean works out to 45.16%.
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 10 Further the R 2 differs from year to year. This suggests that the role of EPS in determination of market value differs from year to year. As we have already noted EPS is only one accounting variable affecting the market value of the equity share. There are many other variables, which are also found to affect the equity values. The role of those variables vis-a-vis EPS changes year after year. Hence the explanatory power of EPS differs from year to year. Table 5 Summary of regression coefficient Year Beta Std error of beta t - values p - values 2006-07 25.85 3.88 6.66 0.000 2007-08 9.98 2.98 3.00 0.000 2008-09 11.48 1.80 6.30 0.000 2009-10 25.89 2.56 10.01 0.000 2010-11 16.69 2.30 7.03 0.000 Next, in Table 5 we have the details regarding the regression coefficients beta in all the years from 2006 07 to 2010 11. We find that the regression coefficients in all the 5 years are significant at 5% level. Beta gives the rate of change of the dependent variable i.e. market value of the equity per unit change in EPS. Thus if EPS of a company increases (decreases) by Re 1 the market value of equity of equity increases (decreases) by an average of Re 25.85 in 2006-07
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 11 But this measure suddenly falls to Rs. 9.98 in the next year i.e. 2007-08. Then increases marginally to 11.48 in the year 2008-09. It jumps to Rs. 25.89 in the year 2009 10. Then falls to Rs. 16.69 in the year 2010 11. Figure 1 depicts a line graph of the betas over the 5 years that we have studied. We fail to make any meaning out of the graph. We need to study the data over a much longer period to study the secular trend and cycles in the value of the regression coefficients. Figure 1: Line graph showing Beta values for 5 years 2006-07 to 2010-2011. 30 Beta 25 20 15 10 Beta 5 0 2006-07 2007-08 2008-09 2009-10 2010-11
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 12 Table.6 Intercept analysis between Market Value and EPS Year Intercept Standard error t values p values 2006-07 16.69 14.18 1.17 Not sig 2007-08 72.05 18.81 3.80 0.000 2008-09 10.01 12.77 0.78 Not sig 2009-10 27.85 15.47 1.78 Not sig 2010-11 66.25 22.80 2.90 0.000 Table 6 shows intercept analysis between market value of equity and EPS. Intercept values except for year 2007-08 and 2010-11 are not significant. We are in-conclusive regarding the intercept values. We need to analyze the data over a longer period of time to get a clear picture of the behavior of the intercept. We have analyzed data over only 5 years. We see that regression coefficient beta is significant in all the 5 years that we have analyzed. Hence we can conclude that EPS and market value of equity share in the Indian context are positively related. We accept the hypothesis of this study. Summary and Conclusion In this paper our focus is on the impact of EPS on the market value of an equity share. The study is based on the cross sectional time series data of 50 companies.
Journal of Finance, Accounting and Management, 3(2), 1-14, July 2012 13 We can conclude that EPS impacts the market value of an equity share in the Indian context. The study needs to be extended to longer time period to be able to describe the exact statistical relationship between EPS and market value of an equity share. Further EPS can explain on an average about 45% of variation in market value of equity. We note that there are a number of accounting variables impacting market value of an equity share other than EPS. When we consider all of them together, the explanatory power of the multiple regression equation will certainly improve. Limitation The study has a number of limitations. The conclusions are based on an analysis of only five year data. To make generalizations of dependence, we need to take samples of companies over about 25-30 years, and run a panel data regression. Also, there are a number of other accounting variables. When they are also considered, the explanatory power of the regression will improve. References Ball, R., Brown, P., (1968), An empirical evaluation accounting income numbers, Journal of Accounting Research6, 159-177. Bar Yosef, S., J., Callen, and J., Linvat, (1987), Autoregressive modeling of earnings investment cuasality The Journal of Finance 42:11-28.
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