A COMPARATIVE STUDY OF THE RELATIONSHIP BETWEEN STOCK PRICE PERFORMANCE AND FIRM’S PROFITABILITY

SUNDAY C. NWITE

SENIOR LECTURER

DEPARTMENT OF BANKING AND FINANCEEBONYI STATE UNIVERSITY – ABAKALIKI

PHONE NO: 080-37743134E-MAIL: nwitewhite2006@yahoo.com

ABSTRACT

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In Nigeria, there are many investors. Most of the investments are done on stocks, equities, shares etc. investors prefer to invest in the area that has better performance and profitability. In most cases, because of the volatility of the market, they seek advise on the market, the annual report of such companies for at least five years. There are a lot of attractions to invest. It is one of the best ways of savings, and an idle fund is also a wasted fund and it is also an avenue to have a seat on the board. The share certificates can easily be converted into liquidity and also act as collaterals. This work therefore wants to look at the relationship between the stock price performance and their profitability. And it was found that such firm that make more profits do therefore have a better performance of their stock prices. Conclusion was drawn that that the stock price performance influences the profit of the firm. Recommendations were made that investors should always consult analyst of the stock market, professionals, stock brokers. They can also seek information from other research professional bodies. This will help them to understand companies that do well and the ones that are not doing well so that they will know the one to invest.KEYWORDSStock price, performance, profitability, collaterals, seat on the board.PAPER TYPE: RESEARCH PAPER

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INTRODUCTION

The capital market is the long-term financial market. It is made up of

primary and secondary market and institutions, which facilitate the

issuance and secondary trading of long-term financial instruments.

The capital market provides funds to industries and governments to

meet their long-term capital requirements, such as financing for

fixed investments, etc. The Nigerian stock exchange as a vision to

promote capital formation in the country by providing issuers and

investors with a responsive, fair efficient stock market (Ahmed,

2008).

The Nigerian capital market (NCM) first came into existence in 1960

with the establishment of the Lagos Stock Exchange.

Before the establishment of the Lagos Stock Exchange in 1960,

almost all formal savings and deposits went through the banking

system while major capital balance were invested for the country by

the British on the London Stock Exchange. The purpose of

investment in stocks shares and equities is to make profit by

dividend payout or to increase the volume of the shares by

ploughing back the profit made.

In most cases, people prefer those companies that are doing well in

the Nigerian Capital Market. It is a believe that companies that are

doing well will make more profit all these are assumptions. The work

wants to have a comparative study on the relationship between

stock prices and profitability of the firm, to know whether such

assumptions are true or not using published data.

HISTORICAL DEVELOPMENT OF NIGERIAN CAPITAL MARKET

The beginning of the capital market in Nigerian can be traced to the

country’s colonial administration which in the 1946 established a 10

years plan for Nigerian under which long-term funds were raised in

the United Kingdom and Nigeria for financing small community

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improvement project, educational research and educational

infrastructure and to induce private sector industrial and agricultural

development (Okereke, 2000).

Formal capital market activities in Nigeria came into existence with

the establishment of the Lagos Stock Exchange in March 1960 and in

September 15, 1961, it commenced business before the

establishment of the Lagos State Exchange, almost all formal

savings and deposits went through the banking system while major

capital balances were invested for the country by British on the

London Stock Exchange. The exchange started operations with 19

securities listed for trading. In an effort to accelerate the orderly

growth of the capital market in Nigeria, the federal government in

1962 established the Capital Issue Committee. The committee was

changed, inter-alia with the responsibility of regulating the timing of

public issues of securities. To further strengthen the regulatory

oversight of the capital issue committee was later changed to

Capital Issue Committee (CIC) under the Capital Issue Committee

Act (1973). In 1977 following the federal government review panel

headed by Dr. Pius Okigbo, the Lagos Stock Exchange was changed

to Nigerian Stock Exchange.

Following a comprehensive review of the Nigeria financial system in

1978, the Securities and Exchange Commission (SEC) was

established by the promulgation of the SEC (1979). The Act was

enacted at a time when the indigenization exercise was in progress

and the commission was saddled with the responsibility of valuing

the shares of enterprises.

There are other landmark events in the history of capital market

among which were the setting up of Adeosun and Okigbo panels, the

inter-ministerial communities, the review of companies and allied

matters and the indigenization decrees.

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In 1996, the federal government set up a panel on the review of the

Nigerian capital market known as Oditte Panel. The panel submitted

its report in October, 1996 with recommendations to the federal

government which were the urgent need to mobilize the country for

prosperity, to provide facilities for capital mobilization and trading in

the rural areas in form of capital trade points (mini stock exchange)

and the establishment of a technology driven national exchange in

Abuja to be known as the Abuja Stock Exchange (ASE) to operate to

international standards. Abuja Stock Exchange was incorporated as

a public liability company on June 17, 1999 and received its license

to operate as full fledged community exchange on August 1, 2000.

Other branches of stock exchange in Nigeria includes:

Kaduna, 1978; Port – Harcourt 1980; Kano 1989, Onitsha February

1990; Ibadan August, 1990; Yola April 2002 and Benin 2005.

THE REASONS FOR THE EXISTENCE OF NIGERIAN CAPITAL

MARKET

The Nigerian capital markets just like its counterparts in other

countries have a lot of reasons to perform in other to ensure

economic development; there are:

1. Provide an additional channel for engaging and mobilizing

domestic savings for productive investment and represents

an alternative to bank deposits, real estate investment and

the financing of consumption loans.

2. Provides depositors with better protection against inflation

and currency depreciation.

3. It fosters the growth of the domestic financial services sector

and the various forms of institutional savings such as life

insurance pension funds.

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4. It improves the gearing of the domestic corporate sector and

helps reduce dependence on borrowing.

5. It improve the efficiency of capital and a market mechanism

for management changes as compared with the

administrative or political mechanism of public sector

corporation.

6. To facilitate the transfer of enterprises from the public sector

to the private sector.

7. To encourage privatization by increasing the marketability

access to new issues.

8. Provide access to finance for new and smaller companies

and encourage institutional development in facilitating the

setting up of Nigeria’s domestic funds, foreign funds, and

venture capital funds.

VARIOUS PRODUCTS SOLD IN THE FINANCIAL MARKET

According to Nwite (2005) financial market is where exchange of

financial resources takes place. That is a market where sellers and

buyers of financial resources come into contact. Thus, a financial

market produces an avenue for surplus/idle cash balances to be

employed in areas of deficit finances, as it make short medium and

long-term surplus funds available.

The various products sold in the financial market. There are two

types of financial market. They are money market and capital

market. The components or the products or services sold in the

money market are treasury bills, commercial papers, bankers

acceptance and certificate of deposit. It is a short term credit. On the

other hand, the capital market is a long term market for long term

investments. The types of products sold there are share, securities,

bonds etc.

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VARIOUS TYPES OF MARKET THAT EXIST IN THE CAPITAL

MARKET.

Money. Originally, came in as medium of exchange in the formally

organized market. However, the society later got highly developed

and sophisticated that people, institutions and governments needed

funds to execute projects. There was a direct need for capital,

money or funds.

Consequently, the financial market evolved. The financial market is

divided into money and capital market.

Money market is a forum where short-term capital is sourced.

Therefore, the corporate body, that requires such fund, creates

instruments with which to source such funds. By its nature, the types

of funds sources in the money market are largely debt or loan funds.

The life span of such funds usually ranges from few hours to about

twenty-four months or two years.

This is the financial market where short and medium term finances

are sold and brought. The major reasons behind the establishment

of the money market in Nigeria.

Money market instruments include the following

- Treasury bills

- Banking acceptance

- Commercial papers

- Certificate of deposit

- Treasury bill (TBS): These are short term securities issued by

the federal governments of Nigeria. They mature within two

days from the date of issue and are default free. Instead of

attracting interest, these promissory notes are sold at the

discount.

- Certificate of Deposit (COD): They are inter bank debit

instrument meant to provide outlets for the commercial banks

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surplus funds. This scheme which was introduced in the country

by the central bank of Nigeria in 1995 was meant to open up a

new source of funds for the Merchant Bank. The two types of

certificates of deposits are negotiable and non-negotiable

certificate of deposit.

- Commercial paper bills: These are promissory notes in

various denominations, issued by the Central Bank of Nigeria

with maturity period of 50 to 270 days. Commercial bills may

also be sold by major companies (Blue-chips) to obtain a loan.

In this case, such notes are not backed by collateral; rather

they rely on the high credit rating of the issuing companies.

- Banker Acceptance: On introduction in 1975 by the central

Bank, was originally meant to mop up excess liquidity in the

banking system. It was aimed at broadening the market for

federal government stock. And so commercial banks holding of

the stock are accepted as a part of their specified liquid assets

and are accepted as a part of their specified liquid assets and

are accepted as a part of their specified liquid assets and are

accepted as a part of their specified liquid assets and are

accepted as a Part of their specified liquid assets and are

repayable on demand. Under the BUF, Federal Government

stocks of 3 years of less to maturity were designated Eligible

Development stocks (EDS) for the purpose of meeting the

bank’s specified liquid assets requirements.

Capital Market: The capital market is a financial market

where long-term financial market where long-term financial

securities are traded on. It is a market that brings together

suppliers and buyers of long-term finances for investment.

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The Comparative study of the relationship price and firm profitability in capital market.Trend between stocks of companies and profitability.

YEARS STOCKS PROFIT (N6000)

GROWTH RATE IN STOCK.

GROWTH RATE IN PROFIT.

1997 132073 702,986 - -1998 176,096 727,363 33.3 3.51999 264,143 751,740 50 3.42000 264,143 1,064,168 0 41.62001 330,178 1,647,836 25 54.82002 375,315 2249078 13.7 34.52003 375315 2684927 0 19.42004 500420 2812623 33.3 4.82005 500420 27107221 0 -3.82006 550420 4665459 10 72

Source: The Nigerian Stock Exchange fact book 2002.The Annual Report and Account of Cadbury 2006.

The comparative Analysis of the share price and firms profitability of companies with Reference to Cadbury Nigeria plc.Between share price and profitability of Cadbury Nigeria plc.

Year Growth Rate in share

price

Growth Rate

Profits.

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

-

-12

-19.3

20.8

62.8

-2

113.3

-8.6

12

-45.1

-

3.5

3.4

41.6

54.8

34.5

19.4

4.8

-3.8

10

Source: The Annual Report and Accounts of Cadbury 2006.The Nigerian Stock Exchange fact book 2002 Newspapers.

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Trend Between share price and profitability of Nestle Nigeria plc.

Year Growth Rate in share

price

Growth Rate

Profits.

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

-

-49.1

-2.3

136.1

48.7

25.1

56.9

13.6

31.2

20.9

-

10.50

56

28.6

57.4

25.8

19.7

0.8

38.3

6.7

Source: The Annual Report and Accounts of Cadbury 2006.The Nigeria Stock Exchange fact book 2002 Newspapers.The Relationship Between share price and firms profitability.

Year Growth Rate inshare price

Growth Rate Profits.

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

22.9

18.1

14.6

18.8

30.61

30.0

64.0

58.52

65.52

35.95

703

727

752

1064

1648

2249

2685

2813

2711

4665

Sources: The Annual; Report and Accounts of Cadbury 2006.The Nigerian Stock Exchange fact book 2002 Newspaper (31ST December of each year).

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The Relationship Between Earning per share and firms

profitability.

Years Earning per share. Profits. N000

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

1.71

1.41

1.51

2.02

2.06

3.00

3.57

2.81

2.70

4.28

703

727

752

1064

1648

2249

2685

2813

2711

4665

Sources: The Annual Report and Accounts of Cadbury 2006. The Nigerian Stock Exchange fact book 2002

METHODOLOGYYears X Y X2 Y2 XY X-X

X1(X-X)2 Y-Y

YI(Y-Y)2

1997199819992000200120022003200420052006 Σ

70372775210641648224926852813271146650017

22.918.114.618.830.6130.064.058.5265.5235.95357

494209528529565504113209627159045058001720922579129697349521217622255428183

524.41327.61213.16352.44936.9790040963424.594292.871292.416361.45

16098.713158.710979.22003250445.2867470171840164616.78177624.72167706.75859943.31

-1298.7-1274.7-1249.7-937.7-353.7247.36803.3811.370932663.30

1686621.691624860.091561750.09879281.29124103.6961157.29466898.89658207.69503106.497093166.8914660153.21

-13-17.8-213-17.1-5.29-5.928.122.6229.620.050

169316.84453.69292.427.9834.81789.61511.66817340.00253473.34

x = Σx = 20017 = 2001.7N 10

y = Σy = 359 = 35.7N 10

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Formular

Y = bo + bi xi + E

Sp = bo + bi pi + E

Where:

bo = y - bi x

bi = n Σxy – (Σy) (Σx)

n Σx2 – (Σx) 2

bi = 10 (859943.31 – (359) (20017)

10 (54728183) – (20017) 2

bi = 8599433.1 – 7186103

547281830 - 400680289

bi = 1413330.1

14660541

bi = 0.0096

Also;

bo = y - bi xbo = 35.9 – 0.0076 (28017)

bo = 35.9 – 19.21632

bo = 16.68368

= 16.684

Sp = 16.684 + 0.0096 PL + 2

The computation above signified that there is a significant

relationship between stock prices and firms profitability and it is a

positive relationship. The partial coefficient of the regression line

signifies that 0.0096% change in the firm’s profitability can be

associated with 1% change in stock price.

Solving to get the coefficient of determination “12” we get the

square root of R2, that is R

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R2 = ( n Σxy – (Σx) (Σy) (Σy) 2

( n Σx2 – (Σx) 2 (Σy) 2)

R = R2

R2 = (10 (859943.31 –(20017) (359) 2

(10 (54728183) – (20017) 2 (10 (16361.45 – (359) 2)

R2 i = ( 8599433.1 – 7186103)

(547281830 – 400680289) (16361.45 – 128881)

R2 = (1413330.1 ) 2

(14660541) (34733.5)

R2 = 0.3923

R = 0.3923

R = 0.6263

Thus, from the computed R, the valve is 0.6263 of the total variation

in the stock price can be explained by the profitability. Also the R

calculated shows that a positive relationship exists between

profitability and stock price.

Standard error test

Solving to test for the statistical significant of the coefficient of a

regression line.

Sbo = Σe2 (Σx) 2

(n-k-1) (nΣx21

Sbi = Σe2

(n-k-1) (Σx21)

Σe2 = (1- R2) Σy21

Σe2 = (1-0.3923) (3473.34)

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Σe2 = 0.6077 x 3473.34

Σe2 = 2110.75

Sbo = (2110.75) (54728183)

(101 -1-1) (10) (14660153-21)

Sbo = 1.155175123 x 1011

8x10x14660153.21

Sbo = 1.55175123 x 1011

1172812257

Sbo = 98.496

Sbo = 9.93

Also;

Sbi = 2110.75

(101 -1-1) (14660153-21)

Sbi = 2110.75

8x10x14660153.21

Sbi = 2110.75

117281225.7

Sbi = 0.0001799

Sbi = 0.0134

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DECISION RULE

If the standard error test is less than a half of the numerical valve of

bi i.e if Sbi < bi1/2 accept Hi and reject Ho otherwise accept Ho

and reject Hi.

Therefore, since Sbi = 0.0132 > bi1/2 = 0.0048 we however accept

Ho and conclude that there is no significant relationship between

stock price and firms profitability.

T – Test

Solving to test for the statistical significance of the regression

coefficient profitability.

Formular

tbo = bo

Sbo

tbi = bi

Sbi

tbo = 16.684

9.93

Tbo = 1.680

Also:

tbi = 0.0096

0.0134

tbi = 0.716

at 5% level of significance t – tabulated = 0.05 = 0.25

1-0.025 = 0.975

Degree of freedom

n-k-i

where;

n = 10, k =1

10-1-1 =8

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t0.975 = 2.31

hence,

since t > tt i.e 0716 < 2.31. however, we accept Ho and reject

Hi, measuring that the inclusion of profitability and stock price is

not statistically significant.

SUMMARY OF FINDINGS

The study emphasized that stock price plays tremendous role in

firms profitability using Cadbury Nigeria Plc as a case s study.

The followings were made:

1. There is significant relationship between stock prices and

firms profitability.

2. There is equally a relationship between earning per share

and firms profitability.

3. The fluctuation of the stock prices poses a lot of problems

to the firms profitability.

4. Low level of market awareness pose a challenge to the

Nigeria Stock Market which in turn affects forms

profitability.

5. The regression result show that the t-test between

profitability and stock price is 0.716 which means that the

inclusion of profitability and stock price is not statistically

significant.

6. Finally, on the other hand, a weak positive relationship

exist between earning per share and profitability.

7. Since the coefficient of determination is at 0.95127.

CONCLUSIONS

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the study x-rayed the Nigerian Capital Market and its

relationship with the firms profitability suing Cadbury as area of

the study and thus concluded that stock prices and earning per

share depends nearly on the firms profitability.

Therefore, firms profitability has a positive relationship with

stock prices and earning per share meaning that firm will make

enormous profit when the stock prices are favourable, while the

reverse is the case when stock prices are unforvourable.

RECOMMENDATIONS

Having clearly appraised a comparative study of the

relationships between stock price performance and firm’s

profitability: a case study of Cadbury Nigeria Plc. It is patient at

this juncture to prefer some solutions to these problems

following the findings of the study.

- Firms should be conscious of the development in the

Nigerian Capital Market since their profitability depends

heavily on the stock prices.

- Government through the CBN should strengthen the laws

guiding the operations of the Nigerian Capital Market to

make it more dependable.

- The NSE on conjunction with the SEC should make a

deliberate attempt to increase the number of an improve

the stock market.

- The NCM should further decent realize its offices so that its

gets more closer to investors and users of fund.

- The NCM should as well intensify her public awareness

programme in order to reach the unreached in the country.

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- Finally, improvement should be made on the infrastrutural

problems that still plague the Nigerian Capital Market.

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