Microsoft Word - Profit per Share KKK-new Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 162 Predicting the Profit per Share Using Financial Ratios Khaldoun M. Al-Qaisi Assistant Prof. of finance, Faculty of Business Finance Department Amman Arab University, Jordan E-mail: khaldoun_21@yahoo.com Received: October 21, 2011 Accepted: November 21, 2011 Published: December 1, 2011 doi:10.5296/ajfa.v3i1.1027 URL: http://dx.doi.org/10.5296/ajfa.v3i1.1027 Abstract The objective of this research is to test the effect of financial ratios on the accomplished profit per share. The results of this research have showed that the predictability of accomplished profit per share was reached using the financial ratio, economical ratio and commercial ratio. The use of working capital and peremptory cash ratio and rapid cash were not useful to predict the accomplished profit per share. Keywords: Financial ratio, Economic ratio, Commercial ratio, Working capital, Rapid cash, Profit per share 1. Introduction The predictability of profit per share is considered important for the investors' decisions and shareholders in different companies. If the shareholders or investors were able to predict the profit per share for companies, this indicated they will be able to make good investing decisions. A convincing long-term return reversal effect has been shown in US studies (e.g. De Bondt and Thaler, 1985, 1987; Chopra, et. al., 1992) and in the UK market (Dissanaike, 1997 and 2002, and Arnold and Baker, 2007). Prior period extreme positive return shares (over 3 to 5 years) subsequently under perform the market, whereas those shares that perform the worst over a sequence of years then, on average, produce returns significantly greater than the market as a whole. Studies from around the world have drawn similar conclusions. The phenomenon is demonstrated to be robust to various risk analyses, the influence of size and market-to-book ratio. Another strand of research takes the perspective that the firm’s fundamental values are indicated by information in financial statements. Share prices deviate at times from these, and only slowly gravitate toward fundamental values. Thus, analysis of published financial Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 163 statements can discover values that are not reflected in share prices. Several papers document the market’s inability to fully process the implications of various financial signals (e.g. Foster, et. al., 1984, Sloan, 1996, Michaely, et. al., 1995, Piotroski, 2000 and Hirshleifer, et. al., 2004). Multiple pieces of information available from firm’s financial statements are used to predict future excess returns (Ou and Penman, 1989a, 1989b, Holthausen and Larcker, 1992, Lev and Thiagarajan, 1993, Abarbanell and Bushee, 1997, Richardson, et. al., 2003 and Fairfield, et. al., 2003). Linked to this ‘predictability anomaly’ may be the observation that financial analysts pay less attention to poor-performing, low-volume or small firms (McNicholls and O’Brien, 1997, and Hayes, 1998). They have a bias in recommending those with a strong recent performance (Stickel, 2000, Jegadeesh et. al. 2004). One possible explanation for this is that, on an individual basis, the typical loser share will continue to under-perform. So, despite the documented out-performance of a loser portfolio analysts may risk ridicule and loss of credibility by recommending prior period losers as most of the these recommendations will turn out to be bad. The objective of this research is to: (1) measure and analyze the profit per share through the period 2005-2010 and (2) measure the predictability of profit per share using the profitability ratios. 2. Methodology Amman Stock Exchange Market data was used for ten companies in industrial sectors for the period 2005-2010. The ratios calculated included financial profit, economical profit, commercial profit, exchange ratio, rapid cash, liquidity peremptory, working capital, and profit per share. The research tested one major hypothesis and two sub-ones as follow: The Major hypothesis: There is not any statistical effect of financial ratios on real profit per share. This hypothesis testing the effect of ratios on predicting the profits gained per share in the ten industrial companies. Hypothesis testing will divided to two groups. The first groups testing the effect of profit ratio on the profit per share while the other will be the testing the effect of liquidity testing on the profit gained per share for the ten companies. 3. Results Table 1 showed the financial ratios of the ten industrial companies for the study period. The companies' names were listed in abbreviation as C1 indicating company one up to C10 to indicate the tenth company in the industrial sector. 3.1 The effect of financial ratios on the accomplished profit per share Table 2 shows linear regression of effect of financial ratios on predicting the profit per share. Linear regression was used to test the effect of financial profit ratio on the accomplished profit per share. Table 2 shows positive effect of financial profit ratio on predicting the profit per share accomplished. The coefficient of financial profit was 3.106 and the impact on profit per share was positive. The model was significant with significance p<0.05. The regression Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 164 coefficient was small indicating the effect of other factors that contribute in predicting the profit per share value the function of prediction is: Y = 3.1068 X1 + 0.232159, where Y: Profit per share X: financial ratio 3.2 The effect economical profit on accomplished profit per share Table 3 shows the results of testing the prediction of accomplished profit per share using economical profit. Linear regression was used in this testing. The results of testing showed significant positive effect of economical ratios on the accomplished profit per share. The constant value was 1.523 indicating that the increase of accomplished per share will increase by this value if the economical ratio improved by one unit. The model was significant with F value 21.30 and significant p<0.05. The regression model for this effect was: Y = 1.524 X – 0.209; Where Y: Accomplished profit per share X: economical ratio 3.3 The effect of commercial ratio on accomplished profit per share Table 4 represents the linear regression for the effect of commercial ratio on accomplished profit per share. The table provides model summary. Linear regression testing shows positive effect of commercial ratio on the accomplished profit per share. The effect was significant. The improvement of commercial ratio will improve the accomplished profit per share by 5.45. The model was significant with F value 40.74 with significance p<0.05. 3.4 The effect of different ratios on accomplished profit per share Table 5 represents the effect of commercial, financial and economical ratios on accomplished profit per share. The model predictability was acceptable as the regression coefficient was 0.426 indicating that these ratios can be used to predict accomplished profit per share ratio. Linear regression analysis showed the positive effect of profit ratios on the accomplished profit per share. The effect was limited to the commercial ratio which shows significant effect on commercial ratio (p<0.05). This indicates that there is collinearity which affected the other factors to be included in one model to test the accomplished profit per share. In this concern, the previous regression models showed that each of the included ratio has positive effect on the accomplished profit per share. 3.5 The effect of exchange ratio and the accomplished profit per share Table 6 shows the results of testing linear regression of exchange ratio on the accomplished Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 165 profit per share. The linear regression testing shows positive effect of exchange ratio on the accomplished profit per share but the relation was not significant. Even though the model was not significant and the regression coefficient was small. These results indicate that the exchange ratio cannot be used to predict the accomplished profit per share. 3.6 The effect of rapid cash liquidity ratio on the accomplished profit per share Table 7 shows the linear regression for the effect of liquidity ratio on the accomplished profit per share. The results of testing the effect of rapid cash on the accomplished profit per share shows low regression coefficient 0.0788. The model was not significant with p>0.05. The effect of rapid cash on accomplished profit per share was not significant. These results indicate that there is no effect for rapid cash of the company on the accomplished profit per share. 3.7 The effect of cash peremptory on the accomplished profit per share Table 8 shows the effect cash peremptory ratio on the accomplished profit per share. The regression model for testing the effect of peremptory cash ratio on the accomplished profit per share was not significant (p>0.05). The regression coefficient was very low and close to zero and the effect of peremptory cash ratio coefficient was not significant. 3.8 The effect of working capital on the accomplished profit per share Table 9 shows the linear regression of the effect of working capital on the accomplished profit per share. The regression model showed not significant model for the effect of working capital on the accomplished profit per share (p>0.05). The regression coefficient was close to zero indicating that there is no effect and the effect of working capital was not significant. The effect of the previous ratios (working capital, peremptory cash, and rapid cash) on accomplished profit was not significant using one model (Table 10). 4. Discussion Predicting profit per share is considered one of the motives of financial markets. Profit per share is expected to be affected by financial ratios, economical profit and commercial ratios. The effect of rapid cash, cash peremptory, and working capital was tested on profit per share. The results of this research indicated that the profit per share can be predicted using the financial ratios. The model of testing was highly significant with significant effect of financial ratios on profit per share. Accordingly, the profit per share is triplicated by 3.11 the financial ratio. The results indicated that the economical ratios can be used as predictor of profit per share. The linear regression showed significant model with significant effect of economic ratios on profit per share. The predicted effect indicated that profit per share would increase by 1.5 if Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 166 the economical ratio was one. Moreover, commercial ratio has a positive effect on the profit per share. The testing model was significant and the t-test of the effect of commercial ratio was significant too. The model represents direct relation between the profit per share and commercial ratio. The collinearty among financial, economical and commercial ratios makes it impossible to test the effect on profit per share using the three factors in one model. The results have shown that the effect of exchange ratio, cash peremptory and working capital was not significant, which is indicates that these ratios cannot be used for the prediction of profit per share. 5. Conclusions The objective of this research is to test the effect of financial ratios on the accomplished profit per share. The predictability of profit per share is considered important for the investors' decisions and shareholders in different companies. If the shareholders or investors were able to predict the profit per share for companies, this indicated they will be able to make good investing decisions. The results of this research have showed that the predictability of accomplished profit per share was reached using the financial ratio, economical ratio and commercial ratio. The use of working capital and peremptory cash ratio and rapid cash were not useful to predict the accomplished profit per share. References Abarbanell, J. S., & Bushee, B.J. (1997). Fundamental Analysis, Future Earnings, & Stock Prices. Journal of Accounting Research, Vol. 35, No. 1, Spring, pp 1-24. http://dx.doi.org/10.2307/2491464 Arnold G. C., & Baker, R. D. (2007). Return Reversal in UK Shares, Salford Business School Working Paper. Chopra, N., J. Lakonishok, & J. R. Ritter. (1992). Measuring Abnormal Performance: Do Stocks Overreact? Journal of Financial Economics, 31 p. 235-268. http://dx.doi.org/10.1016/0304-405X(92)90005-I DeBondt, W.F.M., & R. H. Thaler. (1985). Does the Stock Market Overreact? Journal of Finance, Vol. 40, No. 3 July p. 793-805. http://dx.doi.org/10.2307/2327804 Dissanaike, G. (1994). 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Analysts incentives & financial characteristics of Wall Street Darlings & Dogs, Working paper, LaSalle University   Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 168 Table 1. The selected financial ratios for ten industrial company from ASE market for the period 2005-2010. Financial Profit Economicl Profit Commercial profit Exchange Ratio Rapid cash Liquidity peremptory Profit per share Working capital 0.170.46 0.111.601.600.080.25 867116 2010 C1 0.170.39 0.101.701.700.100.22 1047154 2009 0.160.40 0.121.631.630.330.26 1064654 2008 0.180.61 0.141.841.840.480.30 1080073 2007 0.190.52 0.131.811.810.530.28 1135082 2006 0.180.48 0.112.112.110.790.25 1493639 2005 0.271.29 0.526.046.040.325.76 1958172 2010 C2 0.111.37 0.466.266.260.605.22 1768842 2009 0.150.83 0.284.644.640.903.20 1254892 2008 0.010.09 0.037.907.905.060.24 1334138 2007 0.100.70 0.195.945.943.982.13 1387161 2006 0.301.85 0.585.225.223.186.77 1349482 2005 0.100.30 0.122.202.200.160.19 5107758 2010 C3 0.000.01 0.011.501.500.020.01 3354754 2009 0.040.15 0.042.272.270.250.07 4126164 2008 0.050.29 0.073.083.080.660.09 4369614 2007 0.080.41 0.122.852.850.940.16 4773781 2006 0.040.21 0.072.752.750.550.08 4121221 2005 0.210.83 0.244.304.300.830.39 30697941 2010 C4 0.210.98 0.255.335.331.370.36 31846245 2009 0.151.00 0.235.635.631.530.33 30187753 2008 0.171.16 0.256.116.111.690.54 28723629 2007 0.150.92 0.225.555.551.560.44 26263388 2006 0.140.88 0.215.635.631.810.38 24008435 2005 0.260.78 0.994.034.030.872.14 15810423 2010 C5 0.080.14 0.236.726.720.000.48 16638827 2009 0.050.14 0.1816.9916.991.170.56 23628082 2008 0.070.14 0.175.365.360.000.58 20682805 2007 0.100.18 0.205.625.620.000.76 20408306 2006 0.090.13 0.194.124.120.000.57 18882061 2005 0.220.61 0.202.622.620.010.46 1638366 2010 C6 0.180.77 0.203.433.430.860.36 1547982 2009 0.161.00 0.233.743.741.140.39 1461318 2008 0.150.91 0.193.943.940.750.31 1379267 2007 0.211.12 0.233.633.630.310.40 1297689 2006 0.160.52 0.182.382.380.220.27 973290 2005 0.040.45 0.0410.0910.091.990.09 2645714 2010 C7 0.030.37 0.047.347.341.050.10 2626096 2009 Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 169 0.050.28 0.046.276.271.600.09 2625787 2008 0.040.21 0.045.055.051.310.09 2569598 2007 0.070.18 0.063.303.300.920.14 2541091 2006 0.060.21 0.073.793.790.660.12 2444457 2005 0.130.81 0.264.024.021.830.18 5250280 2010 C8 0.040.78 0.224.334.332.390.14 5402303 2009 0.111.41 0.315.715.713.440.20 6119560 2008 0.080.76 0.276.306.304.070.11 7498466 2007 0.101.52 0.368.608.606.320.18 6440674 2006 0.101.51 0.338.198.195.790.17 5712068 2005 0.581.19 0.333.063.061.991.11 90458244 2010 C9 0.621.12 0.313.263.261.990.86 70144651 2009 0.200.59 0.191.841.840.740.45 24803813 2008 0.140.31 0.130.860.860.130.27 -6740163 2007 0.090.15 0.081.391.390.100.15 12704774 2006 0.030.06 0.041.841.840.330.06 23469149 2005 0.520.17 0.171.161.160.140.64 4931068 2010 C10 0.340.12 0.161.901.900.760.41 16989329 2009 0.110.11 0.123.263.261.830.14 11067259 2008 0.090.14 0.112.092.091.410.12 6432480 2007 0.100.15 0.111.851.851.130.12 5273932 2006 0.080.08 0.081.711.711.000.09 5669991 2005 Table 2. Linear regression of effect of financial ratios on predicting the profit per share Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.285522895 0.081523 0.065688 1.286787 Model Sum of Squares df Mean Square F Sig. 1 Regression 8.524233 1 8.524233 5.148038 0.027009 Residual 96.03766 58 1.655822 Total 104.5619 59 Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) 0.232159 0.260409 0.891516 0.376336 Financial profit 3.106808 1.369284 0.285523 2.268929 0.027009 Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 170 Table 3. Regression analysis for the effect of economical profit on profit per share Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.518305308 0.26864 0.256031 1.148255 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression 28.08955 1 28.08955 21.30435 2.22E-05 Residual 76.47235 58 1.318489 Total 104.5619 59 Coefficients(a) Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) -0.20888 0.244259 -0.85517 0.395976 Economical ratio 1.523797 0.330136 0.518305 4.615664 2.22E-05 Table 4. Linear regression for the effect of commercial ratio on accomplished profit per share Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.642375356 0.412646 0.402519 1.029017 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression 43.14706 1 43.14706 40.74796 3.15E-08 Residual 61.41484 58 1.058877 Total 104.5619 59 Coefficients(a) Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) -0.37093 0.212423 -1.74618 0.086074 Commercial ratio 5.454293 0.854448 0.642375 6.383413 3.15E-08 Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 171 Table 5. the regression model for the effect of financial, economical and commercial ratio on accomplished profit per share Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.652910265 0.426292 0.395557 1.034995 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression 44.57388 3 14.85796 13.8702 7.08E-07 Residual 59.98802 56 1.071215 Total 104.5619 59 Coefficients(a) Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) -0.46517 0.246124 -1.88999 0.063939 Financial ratio -0.05251 1.231587 -0.00483 -0.04264 0.966144 Economical ratio 0.466316 0.406916 0.158613 1.145978 0.256678 Commercial ratio 4.566233 1.19566 0.537785 3.819007 0.000338 Table 6. Linear regression for the effect of exchange ratio on the accomplished profit per share Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.159613777 0.025477 0.008674 1.325467 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression 2.663877 1 2.663877 1.51627 0.223155 Residual 101.898 58 1.756862 Total 104.5619 59 Coefficients(a) Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) 0.353835 0.32025 1.104871 0.273778 Exchange ratio 0.078839 0.064025 0.159614 1.231369 0.223155 Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 172 Table 7. The linear regression for the effect of rapid cash on the accomplished profit per share Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.159613777 0.025477 0.008674 1.325467 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression 2.663877 1 2.663877 1.51627 0.223155 Residual 101.898 58 1.756862 Total 104.5619 59 Coefficients(a) Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) 0.353835 0.32025 1.104871 0.273778 Rapid cash 0.078839 0.064025 0.159614 1.231369 0.223155 Table 8. Linear regression results for the effect of cash peremptory on the accomplished profit per share Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.04708566 0.002217 -0.01499 1.341191 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression 0.23182 1 0.23182 0.128875 0.720905 Residual 104.3301 58 1.798794 Total 104.5619 59 Coefficients(a) Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) 0.630645 0.23403 2.694718 0.0092 Peremptory cash 0.044652 0.124382 0.047086 0.358992 0.720905 Asian Journal of Finance & Accounting ISSN 1946-052X 2011, Vol. 3, No. 1: E11 www.macrothink.org/ajfa 173 Table 9. Regression coefficient for the effect of working capital on accomplished profit per share Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.037564133 0.001411 -0.01581 1.341733 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression 0.147544 1 0.147544 0.081957 0.775682 Residual 104.4144 58 1.800247 Total 104.5619 59 Coefficients(a) Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) 0.720811 0.209318 3.443622 0.001072 Working capital -3.1E-09 1.08E-08 -0.03756 -0.28628 0.775682 Table 10. Regression coefficient for the effect of working capital, rapid cash and peremptory cash on accomplished profit per share Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 0.171363329 0.029365 -0.02263 1.346234 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression 3.070501 3 1.0235 0.564738 0.640531 Residual 101.4914 56 1.812346 Total 104.5619 59 Coefficients(a) Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) 0.398095 0.339566 1.172363 0.246015 Rapid cash 0.090491 0.074531 0.183204 1.214129 0.229794 Peremptory cahs -0.03698 0.142689 -0.03899 -0.25914 0.796479 Working capital -4.3E-09 1.08E-08 -0.05216 -0.39459 0.694644