Mean reversion of Singapore property stock prices towards their fundamental values

Abstract

Market critics often cited an apparent lack of relationship between corporate performance and stock prices as the main reason for a poor prediction of stock prices. This study attempts to examine whether prices of 15 sample listed property stocks in Singapore reflect their corporate fundamental values over a ten‐year period from June 1989 to June 1999. Proxies for corporate fundamental values used in our study are earnings per share (EPS), dividends per share (DPS) and net asset values (NAV) of the individual property stocks listed in Singapore. From the Johansen’s cointegration test results, there were long‐run convergence relationships of stock prices with their fundamental values for nine of the 15 sample stocks, which implied some forms of mean reversion process of stock prices towards their fundamental values. For the nine sampled cointegrating stocks, NAV and EPS, particularly in the second‐lag orders, were the most significant fundamental values in explaining the short‐run dynamics of the stock price changes. The error correction mechanism (ECM) was also found to be statistically significant in the long‐run convergence relationships with four sample stock prices. DPSs and lagged changes in stock prices, in comparison, were statistically significant, but in only two of the sample vector ECM relationships. The results imply that institutional investors should pay more attention to the underlying performance of stocks, in particularly the EPS and NAV, in their stock selection process.