FINANCIAL MARKETS AND INSTITUTES
1.1 Background of Study
The report comprises a brief study on Dhaka Stock Exchange Ltd. (DSE) during the period of internship.The report has been distributed in many parts according to nature and requirement of organization.
1.2 Purpose of Study
The purpose of study is to develop skills through learning various aspects of organization. The study enables to get command on bookish knowledge through practical approach and to understand the difference in both approaches. This thing increases the knowledge and brings betterment in working within organizational environment.
The current study will attempt to investigate identify the most influencing factors of Dhaka Stock Exchange Limited. Portfolios managers and investors may find results in this report useful for determining the future behavior and performance of stock prices, for identifying investment approaches, pursuing available investment opportunities, and reducing the probability of high value losses in the market. Moreover, the stock market authority might find the results helpful in avoiding any unexpected catastrophe, controlling market strategies, improving the stock market industry, and assessing the degree to which the stock market may need to be reformed
1.3 Scope of Study
The working in stock exchange is different from other institutions. The DSE own internship schedule bound me to fallow it. It is difficult to study all aspects of organization in a limited time. The functioning in ISE is mostly accounting and Finance departments. The study focuses on field of Accounting and Information System.
1.4 Methodology of Research
The methodology of research consists of all methods, which were possible during the internship program in DSE. The following method were adopted by me-
Interviews
Questionnaire
General observation
Discussion with investors
1.5 Collection of Data
To present the combination and situation of DSE the following sources have been used for the purpose of collecting data:
i. Primary sources:
Primary data are collected through two ways. They are-
· Questionnaire/ Interview:
· Some primary data are collected by taking interview of the employees of DSE.
· Observation:
· Here primary data are collected from DSE during the working hour.
The other sources are-
· Discussion with the members of DSE
· Expert opinion
· Teachers of our department
· Interview with the executives and officers of PKSF
ii. Secondary Sources:
· Annual reports of DSE
· Published documents
· Official files
· Relevant bikes, newspapers and journals.
· Newsletters
1.6 Limitations
There are few limitations to prepare the report. These are:-
· Official secrecy;
· Confidentiality;
It is very difficult to provide any specific example from any file about certain document, as the matter is very sensitive for the DSE
As a financial organization, DSE has some restriction to serve all the real data of PKSF to the general people.
· Insufficient time.
· Business and unawareness of the clients.
Most vital limiting factor is lack of experience and sound knowledge for such research works.
Necessary data and information are neither adequate nor well furnished
An overview Dhaka Stock Exchange Limited (DSE)
2.1 Forewords
The Dhaka Stock Exchange is the prime bourse of the country. Through its nonstop highly fault-tolerant screen based automated trading system, the exchange can offer facilities for transparent and highly efficient mechanism provisions for secondary market activities of shares, debentures and wide varieties of other securities. The Management of the Exchange is vested with the Board of Directors comprising 12 Members elected from the shareholders of DSE, 12 non-elected independent Directors representing different Institutions, Chambers and professional bodies and the CEO.
The overall operation of the exchange is run by a team of qualified executives. The bourse at present offers trading facilities for 310 securities worth Tk. 323.37 billion which accounts for 6.71% of the GDP of the country. The Dhaka Stock Exchange is the rallying point for enterprises to raise capital in Bangladesh. With a nationwide coverage by 230 brokers and dealers, DSE espouses shared vision of Bangladeshi business all over. The exchange maintains the lead in providing a launching pad for mobilizing savings of the public.
2.2 Brief History
The Dhaka Stock Exchange (DSE) was established as East Pakistan Stock Exchange Association Limited on April 28, 1954. Formal trading of the bourse began in 1956. On June 23, 1962, it was renamed as East Pakistan Stock Exchange Ltd. The name of the stock exchange was once again changed to Dacca Stock Exchange Ltd on May 13, 1964. The service on the stock exchange continued uninterrupted until 1971. The trading was suspended during the liberation war and resumed in 1976 with the change in economic policy of the government.
Since then the bourse did not look back and continued its journey contributing to the development activities of the nation. On August 10, 1998 the DSE introduced screen-based state-of-the-art automated online real-time trading through Local Area Network (LAN) and Wide Area Network (WAN). On January 24, 2004, Later the DSE upgraded its automated trading system on August 21, 2005. Central Depository System (CDS) for electronic settlement of share trading made a debut in the DSE on 1st January, 2004. In its 50-years journey the stock exchange has made significant contribution to the economy of Bangladesh providing the unique platform to raise funds for investment from the market. The stock exchange is in a relentless process of modernization and up gradation of its systems and facilities to accommodate latest technologies available. The SEC approved the Direct Listing Regulations-2006 as proposed by the DSE which paved the way for direct listing of large and profitable companies at offloading shares by government companies through the bourse.
2.3 DSE as an Organization
The Dhaka Stock Exchange (DSE) is incorporated as a Public Limited Company. It is a Self-Regulatory Organization and its activities are regulated by:
· Articles of Association
· Rules and regulations and bye-laws of the exchange
· Companies Act 1994
· Securities and Exchange Ordinance 1969
· Securities and Exchange Rules 1987
2.4 Membership
The DSE has 238 (members) who are also the shareholders of the Exchange. The members are licensed by the Securities and Exchange Commission (SEC) for conducting trading as Stock Dealer or Broker. All Brokerage houses have been corporatized in 2006.
2.5 Policy Making Body
The Board of Directors
Through continuous reforms, Dhaka Stock Exchange has emerged into a modern Exchange. The day to day affairs of the DSE is run by a highly qualified and trained executive team who works independently under policies set by the Board of Directors.
The DSE Board comprises of 25 members of whom 12 are elected through direct election from the 230 shareholders of DSE. The remaining 13 Board Members are Ex-Officio. They include 12 members representing a distinguished personality from different key economic and social arena of the country. The CEO of the Exchange is also a Director of the Board.
One Executive Director of Bangladesh Bank and Managing Director of Investment Corporation of Bangladesh.
· One member representing investors in listed securities.
· One member representing listed issuer companies; and
· The remain 10 (ten) members selected from the elite and other distinguished persons who are not associated either with the Exchange or with any of its members of the exchange.
2.6 DSE Management
A highly qualified and trained team of Executives reporting to the CEO runs the day-to-day affairs of DSE. The management team runs independently under policies set by the Board of Directors. A Head of IT, Secretary and Deputy Finance Controller assist the CEO in managing day-to-day affairs of the bourse.
2.7 Functions of DSE
The major functions are:
o Listing of Companies.(As per Listing Regulations).
o Providing the screen based automated trading of listed Securities.
o Settlement of trading.(As per Settlement of Transaction Regulations)
o Gifting of share / granting approval to the transaction/transfer of share outside the trading system of the exchange (As per Listing Regulations 42)
o Market Administration & Control.
o Market Surveillance.
o Publication of Monthly Review.
o Monitoring the activities of listed companies. (As per Listing Regulations).
o Investors grievance Cell (Disposal of complaint bye laws 1997).
o Investors Protection Fund (As per investor protection fund Regulations 1999)
o Announcement of Price sensitive or other information about listed companies through online.
Other Activities
DSE Publishes Fortnightly & Monthly Review to keep investors community informed on the overall development in securities market. DSE has an arbitration system to resolve disputes or claims against members through a panel of judges comprising 5 retired district judges. Investors Protection Fund which is contributed by the Brokers of the Exchange for the benefit of investors and managed by a board of trusty who are independent body from outside the Exchange.
2.8 Disclosure Requirements of the listed Companies
The listed companies are required to submit-
· Yearly Audited Financial Statement within four months from the year end;
· Half-yearly un-audited financial statement within one month from the date of half year ends.
Disseminating Price Sensitive information within 30 minutes of making any price sensitive decision or Occurrence of price sensitive event.
It is mandatory to follow the following standards in preparation of the accounts
· International Accounting Standards (IAS)
· International Standards for Auditing (ISA).
2.9 Listed Securities
The number of total listed companies is 398 including treasury bonds. The summarized list is as follows:
2.10 Share Categorization: A, B, G, Z & N
The prime bourse of the country introduced “Group A” and “Group B” from July 2, 2000 based on its financial strength and performance to give clear information to investors for taking informed decision. DSE has further categorized the securities by introducing “Group Z” which came into effect from September 26, 2000. The Stock Exchange introduced another company category “Group G” on June 30, 2002. The categorization helps a lot the investors in choosing companies before making investment decision. N Category- the newest one was launched through an order of SEC on July 3, 2006.
Criteria of the Share Category as follows-
· “A’ Category Companies: Companies which are regular in holding the Annual General Meetings and have declared dividend at the rate of 10 percent or more in a calendar year. (Mutual Funds, Debentures & Bond are being traded in this Category)
· “B’ Category Companies: Companies which are regular in holding the Annual General Meetings but have failed to declare dividend at least at the rate of 10 percent in a calendar year.
· “Z’ Category Companies : Companies which have failed to hold the Annual General Meetings or failed to declare any dividend or which are not in operation continuously for more than six months or whose accumulated loss after adjustment of revenue reserve, if any, is negative and exceeded its paid up capital.
· “G’ Category Companies: Greenfield Companies.
· “N’ Category Companies: All newly listed companies except Greenfield companies will be placed in this category and their settlement system would be like B-category companies.
2.11 DSE Clearing & Settlement Process
The Clearing and Settlement module provides the management of trade from the point of entry into the Settlement Pool trade database until it has been delivered, settled and removed from the Settlement Pool. It consists of three major business processes.
Clearing: Participant trade reporting, affirmation, billing and assigning settlement instructions
Settlement: The process of overseeing that delivery of all instruments to the buyer and payment of all moneys to the seller has occurred before removing the trade from the settlement pool.
Regulation 4 of the Settlement of Stock Exchange Transactions Regulation 1998 has been given effect time to time. A new directive was made by SEC dated on 18th March 2003 “Adjusted due position mechanism for settlement of scrip only as provided by regulation 4(1) of settlement of Stock Exchange Transaction Regulations, 1998 shall remain suspended from 19th March 2003 until further order”.
Here is a complete picture of the settlement system for all of our 395 Instruments in Five (5) groups in the Four (4) markets.
A Group:
Number of Instruments are 332 (171 + 8D + 18M + 135TB), Here D for Debentures, M for Mutual funds & TB for Treasury Bonds (Trading in Public, Block & Odd-lot Market with trade for trade settlement facility for scrip only through DSE Clearing House on T+1, T+3 basis). “A” and “DA” are marked in BASES columns for Non-Demat & Demat instrument respectively in our TESA Trading Software.
The above cycle is valid for A, B, G & N category instruments traded in Public, Block & Odd-lot market.
B Group:
Number of Instruments are 25(Trading in Public, Block & Odd-lot Market with trade for trade settlement facility through DSE Clearing House on T+1, T+3 basis). “B” and “DB” are marked in BASES columns for Non-Demat & Demat instrument respectively in our TESA Trading software.
G Group:
Number of Instrument is 0 (Trading in Public, Block & Odd-lot Market with trade for trade settlement facility through DSE Clearing House on T+1, T+3 basis). “G” and “DG” are marked in BASES columns for Non-Demat & Demat instrument respectively in our TESA Trading software.
N Group:
Number of Instrument is 6(Trading in Public, Block & Odd-lot Market with trade for trade settlement facility through DSE Clearing House on T+1, T+3 basis). “N” and “DN” are marked in BASES columns for Non-Demat & Demat instrument respectively in our TESA Trading software.
Z Group:
Number of Instruments are 32(Trading in Public, Block & Odd-lot Market with trade for trade settlement facility through DSE Clearing House on T+1, T+9 basis). “Z” and “DZ” are marked in BASES columns for Non-Demat & Demat instrument respectively in our TESA Trading software.
This cycle is valid only for Z group instruments traded in Public, Block & Odd-lot market.
Instruments Of All Groups Traded In Spot Market:
The above cycle is valid for A, B, G, N & Z category instruments traded in spot market.
Instruments of Foreign Trades (DVP) Of All Groups:
The above cycle is valid for A, B, G, N & Z category instruments of foreign trade.
Remarks:
· If any instrument declared as Compulsory Spot then Trades of Block and Odd-lot market of that Instrument will be settled like Spot Market.
· Howla Charge, Laga Charge & Tax are always payable to DSE at Pay-In date for both Buyer and Seller traded in Public, Block & Odd-lot Market.
· Howla Charge, Laga Charge & Tax are always payable to DSE at T+1 day for both Buyer and Seller traded in Spot Market.
· Outside-Of-Netted settlement for “A” Group instrument has been withdrawn from 10th Dec 2006.
· DVP Trades are Off-Market Settlement (Broker to Broker).
Settlement for different categories instruments
01) For A group Instruments:
| Market name | Trade for Trade System | Settlement & Settlement Period |
| Public | Trade for Trade * | T+1 & T+3 |
| Odd + Block | Trade for Trade | T+1 & T+3 |
| Spot | Trade for Trade | T+0 & T+1 |
02) For B group Instruments:
| Market name | Trade for Trade System | Settlement & Settlement Period |
| Public | Trade for Trade * | T+1 & T+3 |
| Odd + Block | Trade for Trade | T+1 & T+3 |
| Spot (Before Book-closer) | Trade for Trade | T+0 & T+1 |
03) For G group Instruments:
| Market name | Trade for Trade System | Settlement & Settlement Period |
| Public | Trade for Trade * | T+1 & T+3 |
| Odd + Block | Trade for Trade | T+1 & T+3 |
| Spot (Before Book-closer) | Trade for Trade | T+0 & T+1 |
04) For N group Instruments:
| Market name | Trade for Trade System | Settlement & Settlement Period |
| Public | Trade for Trade * | T+1 & T+3 |
| Odd + Block | Trade for Trade | T+1 & T+3 |
| Spot (Before Book-closer) | Trade for Trade | T+0 & T+1 |
· As netting system for shares has withdrawn, for A, B, G & N group instrument, member will have to deposit the full shares at the DSE on T+1 after selling the shares, In case of purchasing such shares, the buyer will have to deposit the Balanced (Netted) money traded in Public, Block & Odd-lot market at the DSE on T+1.
05) For Z group Instruments:
| Market name | Trade for Trade System | Settlement & Settlement Period |
| Public | Trade for Trade * | T+1 & T+9 |
| Odd + Block | Trade for Trade | T+1 & T+9 |
| Spot (Before Book-closer) | Trade for Trade | T+0 & T+1 |
· Under the Trade for trade settlement system, member will have to deposit the full money at the DSE on T+1 after purchasing the shares, In case of selling such shares, the seller will have to deposit the full shares at the DSE on T+9.
2.12 DEMATE SHARE:
All selling shares have to transfer (Pay in) to the clearing account of selling Brokers from concerned BO account within settlement period. Regarding the cash payment the procedure will remain unchanged as mentioned above.
2.13 Key Market Segments
Public Market: For General Trading of Securities
Spot Market: For pre-book closer trading
Trading Lots: Market lots vary from 1 share to 500 shares depends at par value.
Block Market: Block Market transaction involved trading of Tk. 0.5 million or above
Odd Lot Market: Any transaction for odd lot
Foreign Transaction: May be exerted using custodial banks (Standard Chartered Bank,
HSBC & City Bank NA) through DVP process (delivery vs. payment)
2.14 Trading Session
Trading at DSE is performed through a Non-Stop Platform in following sessions:
Continuous Trading Hours (BST) : 11.00 am to 3.00 pm
Trading Day : Sunday to Thursday
2.15 DSE Indices DSE All Share (DST), DSE General & DSE 20:
The all Share Price Index (DSI) comprises all listed securities of the exchange which has been calculated since November 01, 1993 calculated on the basis of price movement of individual stocks using IFC method. Earlier a price average index was in practice which was not perfect.
Algorithm of DSE Indices:
Index Calculation Algorithm (according to IOSCO Index Methodology):
Yesterday’s Closing Index X Current M.Cap
Current Index = ————————————————————–
Opening M.Cap
Yesterday’s Closing Index X Closing M.Cap
Closing Index = ————————————————————–
Opening M.Cap
Current M.Cap = ? (LTP X Total no. of indexed shares)
Closing M.Cap = ? (CP X Total no. of indexed shares)
There are three indices in the DSE as follows:
| Sl. No | Index Name | Base Index | Remarks |
| 1 | DSI (all shares) | 350 (as on 01-11-1993) | |
| 2 | DGEN
(A, B, G & N) |
817.63704 (as on 24-11-2001) | SEC directive regarding index was on 17-11-2001 |
| 2 | DS20 | 1000 (as on 01-01-2001) |
Abbreviations and Acronyms:
M .Cap – Market Capitalization
DSE – Dhaka Stock Exchange
IOSCO – International Organization of Securities Exchange Commissions (IOSCO)
LTP – Last Traded Price
CP – Closing Price
All Shares Price Index (DSI)
| Year | Year End Index | High | Low |
| 1998 | 540.22 | 778.68 | 522.6 |
| 1999 | 533.76 | 540 | 480.55 |
| 2000 | 484.44 | 494.15 | 484.44 |
| 2005 | 1275.05 | 1330.56 | 1099.07 |
| 2006 | 1321.4 | 1323.89 | 1280.01 |
DSE general index with a base-index of 817.62 points started on November 27, 2001. The index excludes companies of Z-category and is calculated on the basis of price movement of individual stocks. The entire market capitalization excluding the Z-category is taken into consideration in deriving the general index.
DSE General Index (DGEN):
| Year | Year End Index | High | Low |
| 1998 | 848.41 | 885.17 | 742.98 |
| 1999 | 967.88 | 1015.97 | 742.23 |
| 2000 | 1971.31 | 1994.08 | 934.95 |
| 2005 | 1677.35 | 1999.71 | 1434.65 |
| 2006 | 1609.51 | 1611.42 | 1544.17 |
DSE-20 index was introduced on January 01, 2001. The Index comprises leading 20 shares with a base index of 1000. The criteria taken into account in formulating the index were market capitalization, free float shares in public hands, minimum payment of 10 percent dividend for the last three consecutive years and 95 percent trading day’s liquidity in terms of trading during the last six months. Subjective criteria such as good corporate governance, regular holding of annual general meeting and sector representation were the other key factors for becoming eligible for inclusion in the Index.
2.16 Listing Requirements of DSE as per Listing Regulation 1999 (as amended up to 2OO5)
A public limited company may apply for listing if it has minimum paid-up capital of Taka 20 (twenty) million and shall make a public issue which is subscribed by not less than 400 applicants. The applicant company among others shall furnish the following documents to the exchange:
· Application for listing as per Form I;
· Memorandum & Articles of Association;
· Copy of the Certificate of incorporation;
· Copies of all material contracts and agreements entered into or exchanged with foreign participants, machinery suppliers and any other financial institutions;
· Copy of Consent order issued by the Commission;
· Names of Directors along with directorship of other companies listed on the Exchange;
· Statement of audited accounts for the last 5 years or for a shorter number;
· An undertaking regarding full compliance of Exchange’s Listing Regulations and other securities laws.
2.17 General process of listing with DSE through IPO
The unlisted companies are required to complete certain procedures to get listing. The present process/way of listing, in brief, may describe as follows:
· Every company intending to enlist its securities to DSE by issuing its securities through IPO is required to appoint Issue Manager to proceed with the listing process of the company in the Exchange;
· The Issue Manager prepares the draft prospectus of the company as per Public Issue Rules of SEC and submits the same to the SEC and the Exchange (s) for necessary approval;
· The Issuer is also required to make agreement with the Underwriter (s) and Bankers to the Issue for IPO purpose; After receiving the draft prospectus, the Exchange examine and evaluate overall performance as well as financial features of the company which may have short term and long term impact on the market;
· The Exchange sends its opinion to SEC within 15 days of receipt of draft prospectus for SEC’s consideration;
· After proper scrutiny, SEC gives it consent for floating IPO as per Public Issue Rule;
· Having consent from SEC, the Issuer is required to file application to the Exchange for listing its securities within 5 days of issuance of its prospectus;
· On successful subscription, the company is required to complete distribution of allotment/refund warrants within 42 days of closing of subscription;
· After 100% distribution of shares/refund warrants and compliance of other requirements, the application for listing of the Issuer is placed to the Exchange’s meeting for necessary decision of the Board of DSE;
· The Board of DSE takes the decision regarding listing/non-listing of the company which must be completed within 75 days from the closure of the subscription.
2.18 DSE Direct Listing Regulations 2OO6
Mature companies are allowed direct listing through plea of sale. The following key conditions must be fulfilled to be eligible for direct listing:
· shall have minimum paid up capital of Tk. 100 (one hundred) million;
· shall have no accumulated loss;
· shall be in commercial operation for at least immediate last five years;
· shall have profit in three years out of the immediate last five completed accounting / financial years with steady growth pattern;
· is regular in holding Annual General Meeting (AGM);
· Have a credit-rating of BBB or above.
2.19 Procedure for Making Portfolio Investment by Foreign Investors
Foreign investors and the Non Resident Bangladeshis (NRBs) may invest in securities. To exercise the investment as NRBs/foreigners, one must enter into an agreement with a brokerage house of their choice along with anyone of the following institutions:
· Authorized Dealer of Foreign Exchange
· Custodial Bank
· Merchant Bank (Portfolio Manager)
All NRBs/foreigners for the purpose of making investment must have a Beneficiary Owners (BO) account and a client account opened with any of the brokerage house as well as entering into agreement with the Authorized Dealer or Custodial Bank or Portfolio Manager and thus maintain the investment activities from abroad. List of Brokers together with regular market scenario, fundamental status of the companies listed on the Exchanges and much other relevant necessary information is available on the website of DSE (www.dsebd.org). List of Brokers of the Exchanges, Merchant Bankers or Custodial Banks is available on the web page of SEC (www.secbd.org).
2.20 Incentives for Capital Market
· Corporate tax rate (except banks, insurance & other financial companies) is 30% for listed companies, while is 40% for non-listed companies.
· Tax rebate @ 10% of tax payable is allowed if a listed company declares 20% or more dividends.
· Investment guarantee
· Foreign Private Investment (Promotion & Protection) Act 1980 ensures legal protection to foreign investment in Bangladesh against nationalization and expropriation.
· It also guarantees repatriation of capital and dividend and equitable treatment with local investors.
· Adequate protection is available for intellectual property rights, such as patents, designs & trademarks and copyrights.
Other facilities and Incentives
· Tax holiday for 5 to 10 years depending on location or sector of Industries.
· Special 15 years tax holiday for private power generation companies.
· Facilities for repatriation of invested capital, profit & dividend.
· Exemption of tax on interest on foreign loan.
· Tax exemption on royalties, technical know- how & technical assistance fees.
· Avoidance of double taxation on the basis of bilateral agreements.
· Six month multiple visa etc
Opportunity for foreign Investors
Bangladesh has a liberal industrial policy in order to attract foreign investment. There are limitations on equity participation i.e. up to 100 percent foreign private investment is permitted. All industries are open to private investment. Industries earmarked only for public sector investment are:
· Arms, ammunition and other defense equipment and machinery
· Production of nuclear energy,
· Forest plantation and mechanized extraction within the bounds of reserved forests,
· Security printing (currency notes) & minting and
· Railways & air transportation (except certain domestic routes and air cargo)
For obtaining industries facilities like procurement of land, electricity, gas and sewerage connection, importation of capital machinery and raw materials tax rebate, duty drawback facilities etc. are requested to be registered with the Board of Investment (BOI).
Facilities for Non-Resident Bangladeshis
· Non-Resident Bangladesh investors enjoy facilities similar to foreign investors
· 10 percent reserved quota for non-resident Bangladeshis in primary shares (IPO)
· Foreign currency deposits in the Non-resident Foreign Currency (NFCD) account
A Review of Determinants of Share Prices
3.1 Forewords
The share market has become an essential market playing a vital role in economic prosperity that fosters capital formation and ensures sustainable economic growth. Share markets are more than a place to trade securities; they operate as a facilitator between savers and users of capital by means of pooling of funds, sharing risk, and transferring wealth. Share markets are essential for economic growth as they insure the flow of resources to the most productive investment opportunities.
Share prices change in stock markets on a daily basis. Moreover, during certain times of the year, it is easy to notice that share prices appreciate every morning, and this may take place many times in one day for some stocks. This means that share prices are determined by supply and demand forces. There is no foolproof system that indicates the exact movement of stock prices. However, the factors behind increases or decreases in the demand and/or supply of a particular stock could include company fundamentals, external factors, and market behavior.
Company fundamental factors influencing stock prices might include performance of the company, a change in board of directors, appointment of new management, and the creation of new assets, earning per share, dividend per share, book values etc.
External factors might include government rules and regulations, inflation, and other economic conditions, investor behavior, market conditions, money supply, competition, uncontrolled natural or environmental circumstances directly affecting the production of the company, strikes, etc.
Moreover, the behavior of market participants could be an important influencing factor of stock price.
3.2 Articles & Literature Review
A large number of empirical studies have been conducted about the determinants of stock prices. However, most of these studies dealt with stock markets of developed countries, whereas there has been no such study carried out about the Bangladesh financial markets.
Factors affecting share prices have been studied from different points of view. Several researchers examined the relationships between share prices and selected factors which may be either internal or external. The results show a variety of findings depending on the scope of the study. Some of those factors might be common for all securities. However, it is difficult to generalize the results due to the various conditions that surround share market environment.
Some studies have concluded that company fundamentals such as earning and valuation multiple are major factors that affect stock prices. Other indicated that inflation, economic conditions, investor behavior, the behavior of the market and liquidity are the most influencing factors of stock prices. In addition, the effect of interrelated factors has been covered in some other studies.
The following three sections deal with three types of studies: the first section is devoted to reviewing studies emphasizing internal factors (i.e., company fundamentals). The second section deals with studies emphasizing external factors. The third section discusses studies that have not emphasized internal or external factors.
3.3 Companies’ Fundamentals
In general, companies’ fundamentals such as earning per share, dividend per share, book values, and other factors that reflect companies’ performance are considered internal factors. It is well known that the most important internal factors are earning per share (EPS) and dividend per share (DPS).
3.3. a. Earning-per-share:
· Earning-per-share is generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings valuation ratio.
· It is one of the common financial measures that all companies include in their annual reports, and is used to calculate the price earnings ratio.
· Diluted earnings per share vary from basic EPS by including the shares of convertibles or warrants outstanding in the total number of shares.
· False Impressions about EPS
· Nice looking bar graphs with ever increasing EPS in company annual reports can create a false impression in some cases, as increasing earnings per share does not always equate to increasing profitability.
· Two companies may have the same earnings per share ratio but one may require significantly more capital (equity) to produce the earnings. The one requiring less capital would be considered more efficient, and hence a more desirable investment.
· Companies can increase their EPS by either…
· Doing a better job at running their company – the best way!
· Buying other companies – not always a good idea as many acquisitions do not achieve what they set out to achieve
· Undertaking a share buyback to reduce the number of shares on issue – a great idea providing the shares are selling at below what they are worth when they are bought back.
· However, even though the above activities may potentially increase earnings per share, they do not necessarily improve profitability.
· For example, if a company buys back their own shares at a price greater than their intrinsic value, this could have a damaging affect on profitability. Similarly, taking over another company that has a lower return on equity than acquiring company may increase the EPS.
· But it increases the risk that management may not realize the synergies (efficiencies) that the takeover was planned to achieve.
· While increasing EPS is a desirable attribute of a company, It is worthwhile to determine which of the three factors above is causing it and what the affect on profitability may be.
· Unfortunately, when considering the effect of an acquisition or a buyback, it may take a year or two to see the how the measures impact on the return on equity. So return on equity is the best measure of profitability (ROE).
3.3. b. Return on equity:
A measure of how well a company used reinvested earnings to generate additional earnings, equal to a fiscal year’s after-tax income (after preferred stock dividends but before common stock dividends) divided by book value, expressed as a percentage. It is also known as “return on net worth” (RONW).
It is used as a general indication of the company’s efficiency; in other words, how much profit it is able to generate given the resources provided by its stockholders. Investors usually look for companies with returns on equity that are high and growing.
ROE is a measure of the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. ROE is expressed as a percentage and calculated as:
· Return on Equity = Net Income/Shareholder’s Equity
· Net income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder’s equity does not include preferred shares.
3.3. c. Dividend
Does payment of a dividend affect the price of a stock? Let’s begin by reviewing what exactly a dividend is. If a company has extra money at the end of the year, they might reinvest it in the company. They might then decide to pay those extra earnings out to the stockholders. Ultimately the decision to pay dividends to the stockholders is completely determined by the board of directors of the company. Also the dividend paid by a company to the stockholders is announced yearly.
Companies can decide whether or not they want to pay dividends, how much to pay, and when to pay them. Shareholders have absolutely no say in the payment of dividends. However, companies are not prone to changing their dividend policies very often, since cutting out dividends or decreasing the amount of a dividend, particularly cash dividends, is generally a sign that the company is in trouble. Boards of directors will only increase dividends if they are absolutely certain that the company is doing well enough that it can handle the increase.
Typically, companies pay dividends in two. The most popular and common way to pay dividends to share holders is with cash. Cash dividends are divided among the shareholders of a company in the form of cold, hard cash. This money comes from either current earnings, from accumulated profits, or from the earnings made by reinvesting money into the company. Cash dividends are taxable and count as investment interest/income.
So, does the issuance of cash dividends have any effect on the price of stock? Well, we might think that it would, for various reasons. But, unless the announcement of the cash dividends is a surprise, then the stock’s price will probably not move. Also, if the nature of the dividend is a surprise-if a company normally pays stock dividends and suddenly switches to cash, or vice versa-then the price of the stock will probably move also. But if cash dividends are paid regularly, then they will be taken as a matter of course and will not affect the stock market. If stock prices do change, because the company decides to dramatically reduce or increase dividends, we will probably see the prices change that very day.
What about stock dividends? What kind of effect do they have on stock prices? Stock dividends are a way of paying dividends by giving stocks to shareholders, based proportionally on the number of stocks already owned. Sometimes companies will perform what is called a stock split, which is where they multiply the number of stocks by two, three, or even four. Basically, it’s a really big stock dividend. If investors are planning on staying invested in the company for a long time, or if they don’t need extra money at the time, they can keep their stocks, or they can just immediately sell them for the cash.
The issuance of stock dividends will make the price of the stocks fall. They probably won’t fall very much, but the price will fall on the ex-dividend date, or the day four days before the record date. So if investors know that a company is going to pay its dividends in stock, and they want to buy stock at a lower price, then they will probably want to buy just before or on the ex-dividend date. However, the drop will be low enough that it will probably be equaled out by transaction costs and taxes.
3.3. d. Book value
Theoretically, it’s what a shareholder would receive if the company were liquidated or sold for cash today. As we all know, the books don’t always reflect the reality. How much is a company worth and is that value reflected in the stock price?
There are several ways to define a company’s worth or value. One of the ways you define value is market cap or how much money would you need to buy every single share of stock at the current price.
Another way to determine a company’s value is to go to the balance statement and look at the Book Value. The Book Value is simply the company’s assets minus its liabilities.
· Book Value = Assets – Liabilities
In other words, if you wanted to close the doors, how much would be left after you settled all the outstanding obligations and sold off all the assets.
· A company that is a viable growing business will always be worth more than its book value for its ability to generate earnings and growth.
· Book value appeals more to value investors who look at the relationship to the stock’s price by using the Price to Book ratio.
· To compare companies, you should convert to book value per share, which is simply the book value divided by outstanding shares.
Price to Book ratio:
The Price to Book Ratio (alternately Price to Book, Price to Book Value, Price/Book, P/B, or P to B) is a financial metric used to compare a company’s book value to the share price at which it is currently trading. It is generally calculated by dividing the share price by the book value per share, though it can also be calculated by dividing the company’s market capitalization by the total book value listed on the balance sheet. It is also known as the “price-equity ratio”.
The Price to Book Ratio varies dramatically between industries. A company that requires more assets (e.g. a manufacturing company with factory space and machinery) will generally post a drastically lower price to book than a company whose earnings comes from the provision of a service (e.g. a consulting firm).
Price to Book is often used to gauge a stock’s relative value. A company trading at a low price to book, particularly when compared to other companies in its industry, is thought to be undervalued relative to its share price. However, a low price to book could also be an indication of negative forward looking investor confidence (e.g. poor earnings projections) or a disproportionate amount of Intangible assets on the books, depending on which version of the calculation is used.
As such, when used for security analysis, price to book is often coupled with metrics such as P/E, PEG, Return on Equity, and the Current Ratio to get a better snapshot of the company as a whole.
Generally speaking, P/B is a measure of the share price relative to the value of the company’s total assets minus liabilities, per share. However, in some calculations intangible assets and goodwill are removed from the equation as their value is significantly more subjective and often has no resale value. In this case, the ratio may be referred to as “Price to Tangible Book Value”.
To conclude, a lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, be aware that this varies by industry. This ratio also gives some idea of whether you’re paying too much for what would be left if the company went bankrupt immediately.
3.3. e. General Shifts in Market/Sector Strength
Companies would like to think that their corporate performance is the only thing that should be driving their share price. Unfortunately for them, other forces in the general market can lift or lower share values regardless of what is happening within specific companies.
There’s an old adage that every share trader ought to know: “A rising tide floats all boats.” This means that when you are in a bullish market most shares are going to be going up because the market and the economy in general are going up and growing. On the other hand it also means that when you are in a bearish market most shares are going to be going down because the market and the economy in general are going down or shrinking.
Just as the market in general can be moving higher or lower, certain sectors within the market can also be moving higher or lower. For instance, healthcare shares may be moving higher at the same time retail shares may be moving lower. Bullish and bearish forces within individual sectors can have the same impact on the shares within those sectors as bullish and bearish forces can have on the overall market.
3.3. f. Bonus Issue
Bonus issue is additional shares given by the company to its existing shareholders. By doing so, the company is able to reinvest the dividend cash for better earnings growth. In fact, this is another way for the company to maintain its share price at cheaper rate without splitting the stocks. Bonus issue is also a good way to reward long term stock investor.
Ideally, the share price drops the same ratio of bonus issued. For instance, if the company is giving one new share for each four shares own by the shareholders, the share price will drop by 20%
3.3. g. Right Issue
A rights issue or rights offering to a company’s existing shareholders is an invitation to buy a proportional number of additional securities at a given price (usually at a discount) within a fixed period. It is another form of capital raising.
The price at which the rights trade on the share market will initially be close to the Theoretical Ex-Rights Price (or TERP for short). The TERP is the ‘diluted’ share price – calculated by multiplying the pre-rights issue share price by the ratio of the number of shares previously issued to the new number of shares now on issue. The shares are now theoretically worth less because of the increased number of shares on issue.
By issuing more shares the company is effectively diluting the value of outstanding stock. As the rights issue allows the existing shareholders to buy the newly issued stock at a discount as part of the rights issue, they are compensated for the inevitable share dilution. The discount the rights issue provides them is equivalent to the cost of share dilution.
3.4 External Factors
Gross domestic product, consumer price index, money supply, interest rate are the most important external factors. Stock prices are also strongly driven by the level of economic activity measured by GDP, interest rate, money stock, and financial deregulation.
3.4. a. Gross Domestic Product:
A country’s Gross Domestic Product is the total value of the goods and services it produces in one year. GDP is used as a measurement of the size of a country’s economy and GDP growth is used as a measurement of economic growth.
Components of GDP
GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G) and Net Exports (X – M).
Y = C + I + G + (X ? M)
I (Investment Spending):-
These are investments by business or households in capital. Examples of investment by a business include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households (not government) on new houses is also included in Investment. In contrast to its colloquial meaning, ‘Investment’ in GDP does not mean purchases of financial products. Buying financial products is classed as ‘saving’, as opposed to investment. The distinction is (in theory) clear: if money is converted into goods or services, it is investment; but, if you buy a bond or a share of stock, this transfer payment is excluded from the GDP sum. That is because the stocks and bonds affect the financial capital which in turn affects the production and sales which in turn affects the investments. So stocks and bonds indirectly affect the GDP. Although such purchases would be called investments in normal speech, from the total-economy point of view, this is simply swapping of deeds, and not part of real production or the GDP formula.
3.4. b. Interest rates
The basic theoretical relationship between changes in long-term interest rates and stock prices is inverse. Falling interest rates signal rising stock prices, while inversely, rising interest rates signal falling stock prices. Changes in interest rates affect stock prices inversely for two distinct reasons.
First, as interest rates fall, corporate borrowing costs (to fund expansions, acquisitions, inventories and so forth) decrease, and the outlook improves for future corporate profits. Investors view stock ownership favorably when corporate profits improve.
Second, when interest rates on long-term debt instruments fall to lower, less attractive levels