Stock Return Predictability with Financial Ratios: Evidence from PSX 100 Index Companies

Abstract

The objective of this paper is to investigate the stock return’s predictability by using financial ratios and control variable of PSX 100 Index companies during period from 2001-2014. The current study mainly focuses on investigating better predictor of stock returns. The methodology is based on Ordinary Least Square (OLS) to estimate the multiple linear regression model. The correlation matrix shows that there is no multicollinearity found between variables. The result of F-Limer test shows that the panel data is appropriate while Hausman test shows that random effect model is appropriate to estimate the model. The results reveal that all variables are statistically significant but some variables have negative impact on stock returns such as asset turnover ratio, EPS, inflation, interest rate and GDP. However, debt ratio, return on sales, firm size, market return and Tobin’s-Q have positive and significant impact on stock returns. In conclusion, potential investors not only focus on huge returns for investing in smaller market cap firms but also investing in large market cap firms of PSX 100 Index companies due to reason that large firms benefit from economies of scale. Furthermore, the stock returns are predictable through financial ratios and control variables in PSX 100 Index Companies and investors also set the investment criterion to see the firm size and Tobin’s-Q when investing in large or small market cap companies to earn excess returns.