The market reaction to profitability: Does leverage matter?

Tawfiq Abdel-Jalil,Ghaleb Abu Rumman,Ahmad Daher,Ahmad Bsoul

doi:10.5267/j.ac.2021.6.008

Abstract

This study examined the market reaction to profitability by discussing the impact of dividends yield (DY) and earnings yield (EY) based on leverage (LVRG), as a control variable, on stocks’ prices (SP) of the industrial companies listed on Amman Stock Exchange (ASE), for the whole sample and the two subsamples (low and high leveraged companies). For this purpose, the data of the three samples were analyzed, for seven years from 2011 to 2017. The multiple regression analysis results showed that based on the leverage ratio (LVRG), as a control variable, there is a significant effect of DY on SP at 1% significance level, and an insignificant effect of EY on SP at 5% significance level, in the high leveraged sample. The impact of DY and EY on SP at 5% significance level in the whole and low leveraged samples is insignificant.

Highlights

Management and Investors evaluate the company’s value and performance through stock’s price
This study examined the market reaction to profitability by discussing the impact of dividends yield (DY) and earnings yield (EY) based on leverage (LVRG), as a control variable, on stocks’ prices (SP) of the industrial companies listed on Amman Stock Exchange (ASE), for the whole sample and the two subsamples
This study examined the impact of dividends yield and earnings yield based on leverage, as a control variable, in the Industrial Jordanian companies listed on ASE for the period (2011-2017)

Summary

Introduction

Management and Investors evaluate the company’s value and performance through stock’s price. The initial reason for this makes sense, a company that pays out dividends at a higher percentage of its share price is offering a greater return for its shareholders’ investments. Economic theory suggests that investors in equities should demand an extra risk premium of several percentage points above prevailing risk-free rates (such as rates on Treasury bills) in their earnings yield to compensate them for the higher risk of owning stocks over bonds, (Investopedia online). If the stock price falls, but earnings stay the same or rise, the earnings yield will increase A high ratio of DY to EY indicates that the company is distributing a greater chunk of its profits to the shareholders This is normal in the case of utilities and companies in matured sectors where there is no great scope for expansion of markets or for making acquisitions. In case when the ratio of DY to EY is low you need to be clear that the company needs to earn a much higher ROE to compensate for the lower dividend payouts (Investopedia online)

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