THE IMPACT OF FINANCIAL RATIOS ON STOCK MARKET RETURNS IN THE NIGERIAN BANKING SECTOR
ABSTRACT
This study examines the extent of impact of a broad range of finance based ratios on stock market returns of some selected deposit money banks quoted on the floors of the Nigerian bourse (stock exchange). The finance based ratios utilised include earnings per share ratio (EPS), Price earnings ratio (PE), Market to Book Value ratio (MBV); while Book Value ratio was utilised as a control variable. Using daily stock market returns data for a time frame that ranges from financial year ended 2008 to 2013, the study applied the multiple regression methodology, which enables easy analysis of the impact of a set of independent variables (regressors) on a selected dependent variable (regressand) with particular emphasis on the Nigerian stock market.
 The result showed that earnings per share (EPS) ratio has an insignificant impact on market returns performance of the deposit money banks. The study further revealed that there exist an insignificant relationship between Price to Earnings (P/E) ratio and Stock Returns of Nigerian publicly quoted deposit money banks. The study further revealed that the effects of Market Value to Book Value (MBV) ratio on Stock Returns of Nigerian publicly quoted deposit money banks are relatively insignificant.  Overall, the empirical findings generally support the view that market based financial ratios do have some insignificant positive impact in the stock market returns of a frontier market such as that of Nigeria. The study recommends that Nigeria should strive to develop and implement detailed capital market master plans and country specific financial market reforms. In particular, such reforms should be guided by the adoption of international best practices, and standards covering issues such as banking system regulation and supervision, data dissemination in the financial market, corporate governance and transparency in monetary policies.
 TABLE OF CONTENT
CHAPTER ONE: INTRODUCTION
1.1    Background to the Study                    
1.2    Statement Of Research Problems                
1.3    Research Questions                            
1.4          Objectives of the Study                        
1.5    Research Hypotheses                            
1.6          The Scope Of The Study                        
1.7    Significance Of The Study                        
1.8         Limitations Of The Study                        
CHAPTER TWO:   LITERATURE REVIEW
2.1     Introduction                                
2.2    Conceptual Framework                        
2.3    Theoretical Framework                    
2.4    Prior Empirical Studies                    
2.4.1    Current Ratio and Stock Returns                    
2.4.2     Inventory Ratio and Stock Returns                    
2.4.3    Debt to Equity Ratio and Stock Returns            
2.4.4    Return on Equity Ratio and Stock Returns            
2.4.5    Price to Earnings Ratio  and Stock Returns                
CHAPTER THREE: METHODOLOGY AND MATERIALS
3.1    Introduction                                
3.2     Research Design                    
3.3    Population And Sample of the Study                
3.4     Stock Return Model                        
3.4.1    Operational Measurement of Variables             
3.4.2    Test for Time Series Properties                    
CHAPTER FOUR: EMPIRICAL ANALYSIS
4.1     Introduction                                
4.2     Descriptive Statistics                        
4.3     Regression Results for the Selected Companies            
4.4     Test of Research Hypotheses                        
4.5    Policy Implications                            
CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS
5.1    Introduction                            
5.2    Summary of Findings                    
5.3          Contribution to Knowledge                    
5.4             Conclusions                            
5.5            Recommendations                        
Bibliography                        
Appendix                         
LIST OF TABLE
Table 4.1a: Descriptive Statistics for Access Bank PLC        
Table 4.1b: Correlation Analysis for Access Bank PLC            
Table 4.2a: Descriptive Statistics for Zenith Bank PLC            
Table 4.2b: Correlation Analysis for Zenith Bank PLC            
Table 4.3a: Descriptive Statistics for Wema Bank PLC            
Table 4.3b: Correlation Analysis for Wema Bank PLC                
Table 4.4a: Descriptive Statistics for Unity Bank PLC            
Table 4.4b: Correlation Analysis for Unity Bank PLC                
Table 4.5a:    Descriptive Statistics for Guarantee Trust Bank PLC        
Table 4.5b: Correlation Analysis for Guarantee Trust Bank PLC        
Table 4.6a: Descriptive Statistics for Diamond Bank PLC            
Table 4.6b: Correlation Analysis for Diamond Bank PLC            
Table 4.7: Regression Result for Access Bank PLC            
Table 4.8: Regression Result for Zenith Bank PLC.                
Table 4.9: Regression Result for Wema Bank PLC.                
Table 4.10: Regression Result for Unity Bank PLC.        
Table 4.11: Regression Result for Guarantee Trust Bank PLC        
Table 4.12: Regression Result for Diamond Bank PLC.            
CHAPTER ONE
INTRODUCTION
1.1    BACKGROUND OF THE STUDY
Stock Market plays a very significant role in the economic growth of a country. According to Schrimpf  (2010) there is significant economic aftermath of the existence of stock return predictability. Kheradyar, Ibrahim and Nor (2011), observes that in stocks market, share prices move randomly that is on certain day share prices are likely to go down as well as likely to go up. Such random behaviour became a source of concerns to some of the Financial Economists and followed by further research. Hence such random movement of share prices led to a hypothesis called Random Walk Hypothesis. Random walk hypothesis suggest that it is difficult to predict share prices because stock market prices evolve according to a random walk thus showing upward trend but after some time show downward trend likewise. Hence predicting 100% accuracy of stock return is almost impossible. According to efficient market hypothesis, share prices are fairly priced in the stock market or prices of stock incorporate or reflect all relevant information in the market hence making it impossible for anyone to outperform or beat the market. To know the financial characteristics of companies would be helpful for those who like to understand the difference between them and to provide information like analyst consensus before Investors make a decision to buy or sell stocks. Stickel (1995), Lang and Lundholm (1996), and Barber, Lehavy, McNichols and Trueman (1998) observed that the company performance have the relationship with stock returns; however, different analyst can make the different opinion and consensus. According to Australian Shareholders’ Association observed that financial ratio analysis offers the most logical set of indicators for a share market investor. That is why investors should analyse financial ratios by themselves then compare with consensus from analysts in order to avoid being mislead from unpublished Company information as rumours and perceive desirable return (Gao & Oler, 2011).
Over time researchers tried to find out most accurate variables for predicting stock prices, some were tend towards financial and some were towards profitability ratios that is book to market ratio, price to earnings ratio, dividend yield, and so on some tend towards cash flow ratios like price to cash flow ratio and some focused on macroeconomic variable like interest rate, law and order situation and inflation rate. However the impact of macroeconomic variables on each security will not be alike. In other words, the stock market adapts to business cycle fluctuations in the economy. However, management risk and financial risk as the firm-specific factors or non-systematic risks vary depending on the firm’s structure and the aforementioned risks will be minimized by effective management. In this respect, the fundamental analysis which is used frequently to measure financial performance and risk has a significant influence on the formation of shareholder value.  It is against this background this study attempts to examine the relationship between financial ratios and stock market returns.
1.2     STATEMENT OF THE RESEARCH PROBLEM
The relationship between stock returns and publicly available information has attracted considerable attention in the accounting and finance literature. Starting with the seminal work of Ball and Brown (1968) these studies find that earnings reflect some of the information in stock prices, however, this constitutes only a small proportion of price movements (Kothari, 2001; Chen & Zhang, 2007). These studies attempt to understand the value relevance of accounting information, value relevance simply implies ability of the financial information contained in the financial statements to explain the stock market measures. A value relevant variable is that data or amount in the financial statement that guide investors in their pricing of shares. Investment decision, therefore, centres on the association between stock returns or share price and accounting related information such as earnings, cash flows, book value of equity, firm’s size, and so on. There have been several studies that have been carried out on financial ratios and stock market returns in more developed countries. For instance, Cooper et al. (2003) and Beccalli et al. (2006) observed that the literature on accounting information and stock returns typically excludes banking institutions due to their high leverage and other distinguishing characteristics of the industry such as regulations. In an attempt to close this gap, studies from the banking literature have recently investigated the relationship between bank efficiency, and stock returns. However, despite the substantial number of studies on bank efficiency, this specific strand of the literature remains rather limited with only a handful of country-specific studies covering Australia (Kirkwood & Nahm, 2006), Greece (Pasiouras et al., 2008a), Malaysia (Sufian& Majid, 2006), Spain, Adenso-Diaz & Gascon, 1997), Singapore (Chu & Lim, 1998; Sufian & Majid, 2007), and the US (Eisnbeis et al., 1999).
From a developing country perspective the studies on financial ratios and stock market returns have been limited. In Nigeria, the banking sector forms one of the pillars of economic development. It intermediates funds between the surplus and the deficit economic units, thus stimulating and promoting investments and economic growth and development. It follows that increase in investment in the banking sector will lead to improved performance of the economy. However, for any meaningful investment to occur in the banking sector, quality accounting information regarding share price and other performance indicators are essential. Investors, who are usually different from the management of the investments, only rely on the information supplied by management in the financial statements, in assessing the risk and value of a firm before deciding either to invest or to disinvest. The ability of the financial statement to effectively and satisfactorily guide investors on their investment decisions depends on the value relevance of the information in the financial statements.
In view of the strategic importance of the banking sector to economic development in Nigeria, as it accounts for almost 31% of the total market capitalization, that is N3.91tn out of N18.95tn  and the fact that banking sector was the first among the listed public entities in Nigeria to fully adopt IFRS. Besides, a set of financial statements are meant for diverse users; ranging from management, owners, creditors, employees, government agencies, regulatory authorities, investors, analysts, etc. Particularly, investors wish to know which items in the financial statement are values relevant for investment decisions.
The motivation for our study is twofold. First, majority of the existing studies on financial ratios and stock market returns focus on earnings which are applicable only under special economic settings and fail to consider the role of statement of financial position data. It is therefore not surprising that recent research has shifted towards the use of additional data such as accruals (e.g. Sloan, 1996; DeFond & Park, 2001), revenues (e.g. Jegadeesh & Linvat, 2006), economic value added (Biddle et al., 1997) and efficiency (Alam & Sickles, 1998), to understand how they affect stock prices and returns.
1.3    RESEARCH QUESTIONS
The following research questions emerged against the background of the statement of the research problem to guide the researcher in the study.
1.    To what extent does earnings per share (EPS) determine equity return performance in Nigerian publicly quoted banks?
2.    Is there a significant relationship between Price Earnings (P/E) ratio and equity returns of Nigerian publicly quoted banks?
3.    To what extent does Market Value to Book Value (MBV) ratio determine equity returns of Nigerian publicly quoted banks Return?
1.4          OBJECTIVES OF THE STUDY
The broad objective of this study is to investigate the impact of a set of market-based financial ratios on Stock Returns of companies quoted on the Nigerian Stock Exchange (NSE). Directly derived from the broad objective are the following specific objectives:
1.    determine whether there is significant relationship between Earnings Per Share (EPS) and Stock Returns of Nigerian deposit money banks;
2.    ascertain if there is significant relationship between Price to Earnings (P/E) ratio and Stock Returns of Nigerian deposit money banks;
3.    determine if there is a significant relationship between the ratio of Market Value to Book Value (MBV) and Stock Returns of Nigerian deposit money banks.
1.5              RESEARCH HYPOTHESES
                In order to proffer answers to the research questions and achieve the objectives of the study, the following three hypotheses stated in their null form are posed.
 H01: There is no significant relationship between Earnings per Share (EPS) and Stock Returns of Nigerian publicly quoted banks.
H02:  There is no significant relationship between Price to Earnings (P/E) ratio and Stock Returns of Nigerian publicly quoted banks.
H03:    There is no significant relationship between the ratio of Market Value to Book Value (MBV) and Stock Returns of Nigerian publicly quoted banks.
1.6    SCOPE OF THE STUDY
The study attempts to look at the relationship between financial ratios and stock market returns. The study was limited to the sixteen (16) Nigerian banks quoted on the Nigerian Stock Exchange. Out of the sixteen quoted Nigeria banks in the stock exchange, the study focus on Six (6) quoted Nigeria banks namely: Access bank, Zenith bank, Wema bank, Unity bank, Guaranty Trust Bank and Diamond Bank. The six quoted banks as a percentage of the total Sixteen publicly quoted deposit money banks represents approximately 38% sample size of  the quoted banks in the Nigeria Stock Exchange. The sample period for the study spanned from 2010 – 2014. The sample period of 2010 – 2014 was chosen to enable us capture  more recent happenings/development in the market which are not due to external foreign factors, for example, the period is after the global financial crisis of 2008/2009 which led to a value met down in the Nigeria stock Market with its resultant effects on the value of Publicly quoted firms(Banks in particular).Also , in addition , data for longer period prior to 2010 are not readily available in the Nigeria stock exchange and National Bureau of Statistics. It is therefore very convenient to utilize available data from 2010 -2014Moreover the period naturally incorporates the impact of Financial ratios on stock returns during the pre and post consolidation era with a view to ascertaining if there was any significant impact .
1.7    SIGNIFICANCE OF THE STUDY
The significance of this study is drawn from the basic essence of accounting which implies the need to provide information that is relevant and reliable. Beneficiaries of financial statements use financial ratios to a large extent in order to comment on the current financial situation and to make estimation on the future financial position of firms. Those who benefit from the financial statements can be basically classified into five categories which are Company Managers, Creditors, Shareholders (Investors), Researchers and the Government. These Five category of financial information users use financial ratios for different purposes:
I.    Company Executives to measure the Company's financial performance,
II.     Creditors to see the capability of debt payment,
III.     Researchers to contribute to the body of knowledge of list of Companies that are gold mine for Investors,
IV.    The Government to assess whether the firms contribute to economic efficiency .
V.    The shareholders to determine whether their investments are profitable or not.
The report and findings of this study is believed would help inform investors (existing and potential) in the Nigerian stock market in general and banking industry in particular on issues bothering on  financial ratios and stock market returns for optimal decision making. Also the study will be useful to analysts, management, corporate bodies, The study will serve as a guide for future studies.
1.8    LIMITATIONS OF THE STUDY
In general, the depth and thoroughness of this research was greatly constrained by some factors which were beyond the control of the researcher. For instance the parameter values of the model, once incorporated within the regression model framework are assumed to be constant. This implies that the estimated coefficients are time-specific in nature and tend to be silent on breaks that may occur in the system. However, in reality financial markets are dynamic and market conditions change continuously with time. The regression model framework does not completely capture these shifts in market conditions; and this therefore forms a part of the limitations of the study.
Furthermore, the sample size considered in this study is too small as its emphasis is on Nigeria alone as the focal point of the study; rather than on a larger sample consisting of many countries within and outside Africa. Besides, the fact that we resorted to the use of secondary data implies that we are faced with the biases and imperfections that often plague the use of secondary data worldwide. However these limitations do not significantly affect the quality of the findings and conclusion reached by the study. Moreover, the scope of the study is also limited by the information given in the various financial statements of the companies used, differences in their accounting policies and years and also the validity of the data contained in their financial reports. The findings are also based on our research study conducted in a single country (Nigeria), with emphasis only on certain set of financial ratios; and may yield results that are not generalizable.