Introduction: The determinants of share prices are frequently a topic of debate both in academics and industry. The economists and investors hold different views as far as the pricing of a share is concerned. In an efficient market, share prices would be determined primarily by fundamental factors, such as dividend per share, earnings per share, dividend payout ratio, dividend yield, net worth, size of the firm, etc. To estimate the future share prices, fundamental analysts use stock valuation ratios to derive a share’s current fair value and estimate future value. If fair value is not equal to the current share price, fundamental analysts believe that the stock is either over or under valued and the market price will ultimately drop towards fair value. Fundamental analysts do not pay attention to the advice of the random walkers and believe that markets are weak from efficient. As a result of believing that prices do not accurately reflect all available information, fundamental analysts look to capitalize on perceived price discrepancies.
The various researchers have found important internal factors that determine the share prices for different markets, viz., dividend, retained earnings, size, earnings per share, dividend yield, leverage, payout ratio, and book value per share. The understanding of the impact of various fundamental variables on share price is very much helpful to investors, as it helps them in taking profitable investment decisions.
In the present study, an attempt has been made to study the impact of selected accounting variables, like book value, dividend per share, earnings per share, size of the firm, dividend payout ratio, dividend yield, return on net worth, and P/E ratio on the equity prices of listed companies in Bombay Stock Exchange
Concept of Stock Market
The Securities Contracts (Regulation) Act, 1956, has defined stock exchange as an “association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling the business of buying, selling and dealing in securities”. As an organized security market, it provides marketability and price continuity of shares and helps in a fair valuation of securities in terms of their intrinsic value. Thus, it helps the orderly flow and distribution of savings between different types of investments. It performs an important part in the economic life of any nation, acting as a free market for securities, where prices are determined by the supply and demand forces. Apart from the above basic function, it also assists in mobilizing funds for the government and the industry and to supply a channel for the investment of savings in the performance of its functions.
The Stock Exchanges in India as elsewhere have a vital role to play in the development of the country in the general and industrial growth of companies in the private sector in particular and helps the government to raise internal resources for the implementation of various development programs in the public sector. As a segment of the capital market it performs an important function in mobilizing and channelizing resources which remain otherwise scattered. Thus, the stock exchanges tap the new resources and stimulate a broad based investment in the capital structure of industries.
A well-developed and healthy stock exchange can be and should be an important institution in building up a property base along with a socialism in India with broader distribution of wealth and income. Thus, the stock exchange is a vital organ in a modern corporate business world. Without the stock exchange, a modern corporate economy cannot exist. The system of joint stock companies financed through the public investment has emerged and has put the vast means of finances almost to entrepreneur’s needs.
Finance from external sources, mainly from the investing public, can become possible only when an institute like the Stock Exchange provides opportunities for the conversion of scattered savings into profitable investments with the promise of a reasonable yield and minimum element of risk. Such a mechanism as provided by Stock Exchanges is not merely a source of capital but also a conduit which channelizes the savings into investment along with a free movement of capital.
With the probable exception of a totalitarian state, no government will be able to mobilize resources from the public, if the money market in the form of stock exchange does not exist. The Stock Exchange benefits the entire community in a variety of ways. It enables the producers to raise capital which directly and indirectly gives gainful employment to millions of people on the one hand, and helps consumers to get a variety of goods needed by them on the other. It provides opportunities to savers to store the value either as temporary abode of purchasing power or as a permanent abode of purchasing power in the form of financial assets. It also helps the segments of the savers who put their savings in commercial firms and non-banking financial intermediaries because these institutions avail themselves of the services of Stock Exchange to invest the money thus collected.
The stock exchange comes close enough to a perfectly competitive market allowing the forces of demand and supply a reasonable degree of freedom to operate as compared to other markets specially the commodity markets. This segment of the factor market can be considered as a perfect or a nearly perfect market. Apart from providing a mechanism for transacting business in stock and shares it generates genuine potential for a new entrepreneur to take up initiative in the private sector enterprises and allows the expansion of investing community by offering gainful development of their otherwise sluggish or shy capital. The stock exchange must assume the responsibility of protecting the rights of investors specially the small investors in the Joint stock companies.
Features of Stock Exchange:
(i) Organized Market: Stock exchange is an organized market of securities (shares, debentures, bonds, etc.) where the securities are bought and sold on the floor of a stock exchange. All transactions are regulated by the rules and bye-laws of the concerned stock exchange.
(ii) Formation & Membership: A stock exchange is generally registered as an association or a society or a company. The membership of the stock exchange is restricted to a certain number, and new members are admitted only when there are vacancies. Every member has to pay the prescribed membership fee.
(iii) Members only Can Trade: Stock exchange is only open to the members of exchange also known as brokers. Brokers act as an agent of the buyers and sellers of shares, debentures and bonds. In a stock exchange, transactions take place between members or their authorized agents on behalf of the investors.
(iv) Listed Securities: To be able to trade a security on a certain stock exchange, it must be listed on the respective stock exchange as per the guidelines issued by the exchange. The stock exchanges do not allow trading in each and every company’s securities. Companies which want their securities to be traded on the floor of a stock exchange have to fulfill certain conditions. The stock exchange satisfies itself about the genuineness and soundness of the company to protect the investors from being cheated. Exchanges maintain records at a central location of such securities but now the trade is increasingly moving from physical places to electronic networks enabling speed and reducing cost.
The purpose of a stock exchange or secondary securities market, like any other organized market is to enable buyers and sellers to affect their transactions more quickly and cheaply than they could otherwise. However, since a stock exchange typically deals in existing securities rather than in new issues, its economic significance may be misunderstood. As it is noted above, the primary function of the capital market relates to the channeling of savings into capital formation; hence the capital market’s economic significance stems from its impact on the allocation of capital resources among alternative uses.
But an increase in the volume of securities trading in the stock market does not represent an increase in the economy’s aggregate savings, every purchase of an existing security being exactly offset by the sale of the same security. To place the capital market in proper perspective it is useful to distinguish between the “primary” and “secondary” securities markets. For the economy as a whole, an increase in savings in the form of securities, ownership is measured by the volume of net new issues of securities, while transactions in existing securities represent shifts among owners, which always cancel out in the aggregate. Similarly, transactions in existing securities do not provide additional funds to finance capital formation; here again it is the volume of net new issues which provides additional financing to business enterprises.
An analogy can readily be drawn from the automobile market. The sales of new Maruti cars (new issues) by the Maruti Udyog (issuing firm) provide revenue (investment funds) to the company; transactions in older models of Maruti cars (existing securities) in the used car market (stock exchange) do not. But just as the existence of a resale market for cars affects the willingness of consumers to purchase new Marutis, the availability of an efficient secondary market for securities is one of the more important factors inducing investors to acquire new issues of securities. And the connection between the primary and secondary markets is even stronger in the case of the securities market, since new issues are often close, or even perfect, substitutes for outstanding securities.
The basic economic function of a stock exchange is to provide marketability for long-term investments, thereby reducing the personal risk incurred by investors and broadening the supply of equity and long-term debt capital for the financing of business enterprise. For example, even though the investment in equity shares is fixed for the life of the firm, the ability to shift ownership to others during the course of this period permits more individuals to participate in the long-term financing of companies.
In an economy with a well-developed secondary securities market, the fixed investment of firms is provided by a changing group of individuals, none of whom may have been willing to commit his personal resources for the entire or even a substantial part of the life of the enterprise. Thus, in an efficient stock exchange the supply of credit, which from the private investor’s viewpoint is often inherently short-term, is transformed into a supply of long-term investment funds for the financing of capital formation.
The ability to transfer the risks of investment forges a link between the stock exchange and the new issues market, and this greatly enhances the ability of business enterprises to mobilize additional long-term capital to finance the creation of new, or the expansion of existing production facilities. To effectively fulfill its functions as an allocator of capital, the securities market should be influenced solely by economic considerations; the prices of the various securities should reflect their expected returns and risk characteristics. In an efficient market, current prices for a company’s securities will reflect the investors’ best estimates of the firm’s anticipated profitability and of the risks attached to these profits.
And since–other things being equal–rising stock prices attract investors; the allocation of capital will be biased in favor of firms with relatively high levels of risk adjusted profits. On the other hand, firms with low profitability or excessive riskiness will find it difficult, expensive, or on occasion even impossible to raise additional capital for expansion. The prerequisites for such an efficient securities market are roughly the same as those of any ‘perfect” or purely competitive market: (a) the products traded in the market must be homogeneous; (b) the market must comprise many relatively small buyers and sellers; and (e) there must be free entry and exit into and out of the market.
Although a securities market is made up of many types of securities of a large number of companies, each class of securities is homogeneous in the sense that the risk-adjusted rates of return of the various classes of securities comprise homogeneous commodities. One share of a given risk class is as good as any other and therefore they must sell at the same price. In addition, a modem securities market is made up of a large number of relatively small buyers and sellers so that it is difficult for any individual to influence prices. This rather sanguine view of the stock market and its impact on the allocation of capital is not universally held. To some the Stock Exchange is a den of iniquity; to other, more sophisticated, observer’s stock market prices reflect mass psychology with little if any connection to underlying economic values. The case against the stock exchange was most forcibly expressed during the 1930s by the most famous economist of the time, John Maynard Keynes. In a characteristically brilliant passage which goes a long way towards explaining his own success as an investor, Keynes described the stock exchange as a place where most investors attempt to guess what average opinion thinks. Average opinion will be like one month hence, while others practice the “fourth, fifth and higher degrees” of this art.’
It should be recalled that Keynes was writing at a time when a worldwide financial crisis had so undermined public confidence that stock prices did often appear to be unconnected with any underlying economic values. Taking a somewhat longer view, however, there is really no inherent contradiction between the kind of speculative behavior which Keynes described and the thesis that stock prices, in the long run, reflect economic values. For this purpose, it is sufficient that some investors become conditioned to the fact that stock prices rise when profits and dividends increase, so that it “pays” to exploit all available information in an attempt to anticipate such possibilities. The available statistical evidence suggests that Keynes notwithstanding, the pure speculator does not rule the roost, and therefore the quest for quick capital gains has not divorced the trend in the price of a company’s stock from the expectation of future profits.
Importance of Investors in Stock Markets:
The investor is the backbone of the stock markets and therefore protection of his interests is paramount to the National Stock Exchange. In the prolongation of his interests, the NSE has put in place systems to ensure the obtainability of passable, up-to-date, and correct information to investors to empower them to take cognizant decisions. It guarantees that precarious and price-sensitive evidence reaching the exchange is made accessible to all classes of investors at the identical point of time. Such price-sensitive information as bonus announcements, mergers, new line of business, etc. received from the companies is disseminated to all the market participants through the network of NSE terminals all over India.
Action is initiated by the Exchange, where any kind of price-sensitive information is not provided to the Exchange at the prescribed time. It ascertains the veracity of rumors and disseminates facts in the interest of investors. In an attempt to ease the existing system of information dissemination by the listed companies, NSE launched the electronic interface for listed companies in August 2004. Under the new system, all corporate announcements including that of Board meetings which needs to be disclosed to the market is handled electronically in a straight through and hands free manner.
It also conducts various seminars and programs for the investors all over the country with a view to educate them on their rights and obligations. They are also made aware of the precautions they need to take while dealing in the securities market. It makes an audit trail available on request for all transactions executed on the NSE to enable investors to counter-check trade details for the trades executed on his behalf by the member. It has also prescribed and makes effort to ensure the implementation of various safeguards like time schedules for issuing contract notes, for receiving funds and securities purchased by investors, segregation of client funds and securities from those of members, etc. The exchange has also launched a facility to verify trades on the NSE website.
Using this facility, an investor who had received a contract note from the trading member of the Exchange can check whether the trade has been executed. The NSE has put in place a system for redressal of investor grievances for matters/issues related to/against trading members/companies. The Investor Grievance Cell of NSE is manned by a team of professionals possessing relevant experience in the areas of securities markets, company and legal affairs, and specially trained to identify problems faced by the investor and to find and effect a solution quickly. It takes up complaints in respect of trades executed on the NSE through its NEAT terminal and routed through the NSE trading member or SEBI registered sub-broker of NSE trading member and trades pertaining to companies traded on NSE.
For Citing this article use:
- Challa, K. (2015). Equity share price determinants an empirical analysis.