Analysis of P/E and Size Effects on Vietnam Stock Returns

School of Business Administration - An Analysis on Relations of Price-Earnings Ratios and Market Capitalization to Anomaly Returns Advisor: Le Hong Nhung, MBA Student: Ton That Hue Tri 1

2 Day Trading Value Investment Style Investment Growth Investment Interest Rate Parity Long/Short Gorilla Trading Merger Arbitrage Size Value Factors Sectors Liquidity Technical Analysis Short Bias Market Neutral Distress Investment ,[object Object]

LeverageScalping Trading Event-Driven Global Macro Contrarian Tape Reading ,[object Object],Triangular Arbitrage ,[object Object],Quantitative Directional Volatility Arbitrage ,[object Object], P/E and Size Fixed Income Arbitrage 130-30 Funds

Content Chapter 1 - Introduction Chapter 2 - Literature Review Chapter 3 - Study Design & Methodology Chapter 4 - Result Analysis & Discussion Chapter 5 - Conclusion Appendices 3

Chapter 1 - Introduction Background Context Objectives Implications of the Study 4

[object Object],Chapter 1 – Introduction Background Context Objectives Implications of the Study Chapter 2 - Chapter 3 - Chapter 4 - Chapter 5 - Appendices 5 I don’t know what happened there People got top of the world here, and … Nothing happened here People committed suicide here. Vietnam’s stock market is breath-taking!!!

[object Object],Chapter 1 – Introduction Background Context Objectives Implications of the Study Chapter 2 - Chapter 3 - Chapter 4 - Chapter 5 - Appendices 6 Investigate P/E Effect 3 Main Targets Investigate Size Effect Investigate Combination Effect of P/E and Size Find correlations between Size and P/E 2 Sub Targets Give comment to Efficient Market Hypothesis

[object Object],7 Test the applicable characteristic of theories from advanced countries For Academic Community Chapter 1 – Introduction Background Context Objectives Implications of the Study Chapter 2 - Chapter 3 - Chapter 4 - Chapter 5 - Appendices Proof for Efficient Market Hypothesis Meaningful information for investment strategy For Investment Community Anchor to develop style investment strategies

Chapter 2 - Literature Review Efficient Market Hypothesis Anomalies and Theories on Anomaly Measurements Empirical Researches on Price-earnings Ratio Empirical Researches on Market Capitalization 8

[object Object], - Security prices fully reflect all available information in the market in an unbiased and rapid manner - Eugene Fama (1960s) Chapter 1 - Chapter 2 – Literature Review Efficient Market Hypothesis Theories on Anomalies Empirical Researches on P/E Ratio Empirical Researches on Size Chapter 3 - Chapter 4 - Chapter 5 - Appendices Assumptions: Large number of profit maximizers New information come randomly Profit maximizers adjust prices rapidly to new information 9 Three forms of EMH: Weak-form Semistrong-form Strong-form Debate!!!

[object Object],10 CAPM – Treynor (1961), Sharpe (1964), Lintner (1965), Mossin (1965) Asset Return SML Chapter 1 - Chapter 2 – Literature Review Efficient Market Hypothesis Theories on Anomalies Empirical Researches on P/E Ratio Empirical Researches on Size Chapter 3 - Chapter 4 - Chapter 5 - Appendices Risk-free rate of return Beta Expected Returni = RFR + βi(Market Return – RFR) Difference between expected returns and actual returns Anomaly

[object Object],Nicholson (1960)  Low P/E companies beat the market! 1960s McWilliam, Miller,Widmann, Breen, Savage Chapter 1 - Chapter 2 – Literature Review Efficient Market Hypothesis Theories on Anomalies Empirical Researches on P/E Ratio Empirical Researches on Size Chapter 3 - Chapter 4 - Chapter 5 - Appendices 11 Low P/E Outperform Basu (1977)  Low P/E still outperforms! After several adjustments Johnson, Fiore, & Zuber (1989) Staff (2004)  Canadian Equity P/E Effect, but not from Low P/E No P/E Effect Growth Stock Cyclical Stock

[object Object],12 Smallest Firms Outperform Banz & Reinganum (1981) Chapter 1 - Chapter 2 – Literature Review Efficient Market Hypothesis Theories on Anomalies Empirical Researches on P/E Ratio Empirical Researches on Size Chapter 3 - Chapter 4 - Chapter 5 - Appendices Size Effect = Stable over time! Brown, Kleidon, & Marsh (1982) No Size Effect during 1967-1979 in US Equity Predictive power of Size is unstable Stoll & Whaley (1983) Transaction cost Reinganum (1983, 1992) Holding Period Assumption

Chapter 3 - Study Design & Methodology The Study Design Data Collection Method The Study Construction Hypothesis Testing 13

[object Object],Study Design Summary: Stocks Studied: 161 (Excluded Fund Certificates) Time Scale: Mar 1st 2007 – Mar 1st 2010 Rebalancing Period: 3 months  12 times of rebalancing Total 420 equal weighted portfolios constructed Chapter 1 - Chapter 2 - Chapter 3 – Study Design & Methodology The Study Design Data Collection Method The Study Construction Hypothesis Testing Chapter 4 - Chapter 5 - Appendices P/E Effect 14 Size Effect

15 ,[object Object],Stock’s Prices: Closing price Risk Free Rate: Government 5-years bond quotes Quarterly Profit: Quarterly Reports, Unit used VND 1,000 Outstanding Share Number: Market capitalization divided by closing price Eliminate Look-Ahead Bias: Date of forming portfolios chosen at the beginning trading day of Mar, Jun, Sep, and Dec for Q1, Q2, Q3, and Q4 respectively Eliminate IPO Effect: Stock must be traded 3 months prior to the portfolio forming dates Eliminate Survivorship Bias: Stock, which is excluded from VNIndex for any reason (switch to HNX Index, bankruptcy, etc.), is still taken into portfolios prior to the event’s date Chapter 1 - Chapter 2 - Chapter 3 – Study Design & Methodology The Study Design Data Collection Method The Study Construction Hypothesis Testing Chapter 4 - Chapter 5 - Appendices

[object Object],16 Tickers collected Data Phase Study P/E Effect Tickers  portfolios Chapter 1 - Chapter 2 - Chapter 3 – Study Design & Methodology The Study Design Data Collection Method The Study Construction Hypothesis Testing Chapter 4 - Chapter 5 - Appendices Divide P/E by scale of 5 & reallocate Study Size Effect Data Collected Category daily returns calculated P/E and Size calculated Study Combination Effect Synthesize returns throughout 12 periods Study Correlation of P/E & Size Run Regression each class to market  alpha

[object Object],Chapter 1 - Chapter 2 - Chapter 3 – Study Design & Methodology The Study Design Data Collection Method The Study Construction Hypothesis Testing Chapter 4 - Chapter 5 - Appendices 17 Hypothesis Establishing: H0: μα = 0 – The mean of alpha is equal zero H1: μα≠ 0 – The mean of alpha is statistically significant different from zero Test statistic applied: t-test Population variance is unknown t-test is robust t-test is more conservative to z-test Significant Level: 0.05 level of significance p-value approach: p-value chosen to be 5%

Chapter 4 - Result Analysis & Discussion P/E Effect Size Effect Combination Effect of Size and P/E Correlation of Size, P/E & other Considerations 18

[object Object],Chapter 1 - Chapter 2 - Chapter 3 - Chapter 4 – Result Analysis & Discussion P/E Effect Size Effect Combination Effect of Size and P/E Correlation of Size, P/E & other Considerations Chapter 5 - Appendices As P/E goes lower, mean returns tend to go higher along with alpha Only PE3 – Moderate P/E is found to have reliable positive alpha of 0.06% Contradictory to Nichoson (1960), McWilliam (1966), Midler & Widmann (1966), Breen (1968), & Basu (1977)’s finding that low P/E  outperform Supportive to conclusion of Johnson, Fiore, & Zuber (1989) that there were some abnormal returns by using P/E but those not come from Low P/E 19

[object Object],Chapter 1 - Chapter 2 - Chapter 3 - Chapter 4 – Result Analysis & Discussion P/E Effect Size Effect Combination Effect of Size and P/E Correlation of Size, P/E & other Considerations Chapter 5 - Appendices 20 As Size goes lower, mean returns tend to go higher along with alpha Only MC1’s alpha of 0.09% satisfies 95% confidence interval with p-value = 3% Strongly supportive to Size Effect found by Banz & Reinganum (1981), Reinganum (1983, 1992), and Stoll & Whaley (1983)’s finding that low Market Cap  outperform Is this finding contradictory to Brown, Kleidon, & Marsh (1982)? Not enough evidence to conclude Size Effect in HoSE is a long-run phenomenon or time-period effect

[object Object],Chapter 1 - Chapter 2 - Chapter 3 - Chapter 4 – Result Analysis & Discussion P/E Effect Size Effect Combination Effect of Size and P/E Correlation of Size, P/E & other Considerations Chapter 5 - Appendices 21

[object Object],No Significant relationship found in the correlation between Market Cap and P/E No significant change in results after taking transaction cost into consideration Mean Daily Transaction Cost = (((Buy cost)*8)/(5*52)) 0.000923077% = ((0.03%*8)/(5*52))  The combination effect of Size and P/E is actually come from both factors! Chapter 1 - Chapter 2 - Chapter 3 - Chapter 4 – Result Analysis & Discussion P/E Effect Size Effect Combination Effect of Size and P/E Correlation of Size, P/E & other Considerations Chapter 5 - Appendices 22

Chapter 5 - Conclusion 23 Prices, # of Share, & Quarterly Profits 746 Daily Observations 161 chosen companies

[object Object],Chapter 1 - Chapter 2 - Chapter 3 - Chapter 4 - Chapter 5 – Conclusion Appendices 24 Legend: Effect is proven Effect is not proven

25 : 10 09 08 07 06 05 04 03 02 01 00 00  Thank You for Listening!

Analysis of P/E and Size Effects on Vietnam Stock Returns

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Analysis of P/E and Size Effects on Vietnam Stock Returns