FUNDAMENTAL ANALYSIS IN INDONESIA STOCK EXCHANGE:
A STUDY ON MANUFACTURING COMPANIES
Tatang Ary Gumanti, Ira Septa Ningrum, Hadi Paramu, Elok Sri Utami
Department of Management, Faculty of Economics and Business, University of Jember
Jln. Kalimantan 37, Jember 68121
E-mail: , , ,
Abstract
Fundamental analysis involves an estimate of company values using various measures of fundamental factors of the company. Empirical evidence seems to confirm that fundamental factors inherent in the company are influential of the company stock returns. This research examines the effect of fundamental variables (inventory turnover, accounts receivable turnover, gross profit margin, labor force, and debt to equity ratio) onthe stock returns of manufacturing firmslisted on the Indonesia Stock Exchange. The sample consists of 47 companies selected from a total of 147 manufacturing companies. Results using multiple linear regression analysis show that all fundamental variables have a varying effect on the stock returns. In particular, the study finds that inventory turnover, gross profit margin, and debt to equity ratio have positive and significant effect on stock returns. Whilst, accounts receivable turnover and labor force have negative and significant effect on stock returns. The findings reported in this study affirm the importance of fundamental variables as the potential determinants of company stock returns.
Keywords: fundamental analisis, stock returns, manufacturing companies.
INTRODUCTION
Several studies have been conducted to examine the effect of fundamental factors on the cross-sectional of stock returns. The evidence suggests that many fundamental factors are related to the variation of stock returns, for example Lev and Thiagarajan (1993), Abarbanell and Bushee (1997; 1998), and Sharma and Sharma (2006). These studies assert the importance of the companies’ fundamental factors as determinants of stock returns.
Fundamental analysis includes estimating the value of a company's stock or equity using fundamental factors as the reference in valuing the shares of a company traded in the capital market. Fundamental analysis assumes that a security has certain intrinsic value and firm value can be predicted by using fundamental variables. By comparing intrinsic value with market price of securities, the analysis can know generate reasonable price (according to its intrinsic value). It is assumed that investors would be able to take advantage of the situation to gain profit by buying or selling shares using their estimates through fundamental analysis.
Unlike commonly believed, fundamental analysis does not only relate with accounting or financial information in the determination of company values. Lev and Thiagarazan (1993) and Abarbanell and Bushe (1997) are among the first who assert that non-accounting could also be of potential in determining company values. These studies contend that as long as the variables could serve as proxy for the company risk, any non-accounting information of the company could be used as the determinants of the company value.
A number of studies have been conducted to examine the effect of fundamentals factors of the issuer and the macroeconomic influence of a country on stock returns with different results. For example, Wahyu et al. (2010) and Ashoub and Hoshmand (2012) document that inventory turnover has positive effect on stock returns, but Lev and Thiagarajan (1993), Abarbanell and Bushee (1997), and Seng and Hancock (2012) report otherwise. Abarbanell and Bushee (1997) find that accounts receivable turnover has positive effect on stock returns, but Lev and Thiagarajan (1993) and Wahyu et al. (2010) report the opposite. Some studies find that gross margin is negatively related to the stock returns (Lev and Thiagarajan: 1993, Abarbanell and Bushee: 1997, Seng and Hancock: 2012), but Wahyu et al. (2010) report positive association. Labor force was found to have negative effect on stock returns (Lev and Thiagarajan: 1993, Abarbanell and Bushee: 1997, Seng and Hancock, 2012), whereas Wahyu et al. (2010) do not find significant influence. Nuza (2012) finds Debt to Equity Ratio (DER) has a positive effect on stock returns, but Kennedy (2003) finds otherwise. Thus, empirical results show conflicting findings. This has made the issue interesting to be further tested using different data to seek for the external validity.
In addition to the inconsistency of previous studies, research on fundamental analysis remains important and interesting to do. Fundamental factors to date are still used as one of the basis in making investment decisions related to its function as a media of analysis of stock returns. On the other hand, research on fundamental analysis needs to be continued to test the external validity of previous studies.
Previous studies have examinedvarious sectors to be the objects of the research. The focus of the current research is manufacturing companies listed on the Indonesia Stock Exchange. The manufacturing sector is a combination of three sectors, namely chemical and basic industry, miscellaneous industry, and consumer goods industry. Based on information from the Central Bureau of Statistics, the increase in demand for finished products both domestically and internationally has encouraged the development of the manufacturing sector to become the largest sector of the role in the formation of GDP since 1991. Based on the description that has been elaborated, this article aims to analyze the influence of fundamental variables on the stock returns.
The current study is focused on manufacturing companies. One of the main reason is that the study examine the labor force as also analyzed in previous studies (Lev and Thiagarajan: 1993, Abarbanell and Bushee: 1997, Seng and Hancock, 2012). Inclusion of labor force variable is intended to check whether the manufacturing companies in Indonesia which usually have large number of employees foresee that labor force is important in determining the riskiness of the companies and thus the stock prices.
HYPOTHESES DEVELOPMENT
Inventory turnover indicates how long the goods must be kept in the warehouse before being sold. Smaller inventory turnover ratio indicates that sales activity is decreasing and more finished goods are stored in the warehouse. As a result, the company takes longer time to convert the inventory into cash and this will result in lower profitability. Inventory turnover which increases due to sales increase would make the risk faced by the company to increase. Firms that are able to increase the sales would have lower risks.However, larger sales would be associated with larger risk if the company is unable to proportionate its inventory. In other words, firms that can increase sales in order to pursue targets will face greater risk. Given the possibility of facing greater risk, investors to demand higher return. Wahyu et al. (2010) and Ashoub and Hoshmand (2012) show consistent results that inventory is a fundamental variable that has a positive effect on stock returns.
Based on the argument mentioned above, hypothesis is formulated as follows.
H1: Inventory Turnover has positive effect on the stock returns of manufacturing firm listed on Indonesian Stock Exchange.
Accounts receivable turnover is used to measure a company’s ability to manage funds embedded in the receivables over a given period. Receivable turnover is the ratio used to measure how long the collection of receivables over a certain period or the turnover of the funds invested in these receivables. Accounts receivable turnover in one period is usually 30-60 days. The turnover shall be less than one year. The more soft the terms of payment the longer the capital is bound in the receivables which means lower turnover rate. Increase in accounts receivable turnover is caused by the increasein receivables, so firms must face high risks to obtain high returns. Given accounts receivable turnover decreases as a result of lower receivables, thefirmswould poses low risk and consequently investors would demand lower returns. Abarbanell and Bushee (1997) show thataccounts receivable turnover have a positive effect on the stock returns.
The aforementioned explanations lead us to propose the following hypothesis.
H2: Accounts receivable turnover has positive effect onthe stock returns of manufacturing firm listed on Indonesian Stock Exchange.
The gross profit margin shows the profit relative to the company, by way of net sales minus cost of goods sold. The greater the gross profit margin the better is the state of operations of the company, as it shows that the cost of goods sold is relatively and significantly lower than the sales. This makes the risk faced by the company will be greater and consequently investors will demand higher returns.Conversely, the lower the gross profit margin the less is the company's operations, so that the risk faced by the company is low and consequently it is associated with low returns. However, empirical evidence suggests that profitability has a negative effect on stock returns. Lev and Thiagarajan (1993), Abarbanell and Bushee (1997), and Seng and Hancock (2012) show consistent results that gross profit margin has a negative effect on the return stocks. However, Wahyu et al. (2010) find that gross profit margin has a positive effect on stock returns.
Based on the argument stated above, the study proposes the following hypothesis.
H3: Gross profit marginhas positive effect on the stock returns of manufacturing firm listed on Indonesian Stock Exchange.
The number of labor in a manufacturing company determines the quality of the product it produced, because every workforce has its parts and responsibilities respectively. Larger number of labor should be associated with better performance of a company in producing the products given it has adequate human resource. However, larger number of employees is also related of possible employees’ strike that could affect the continuity of production. In other words, larger number of employees may create larger possibility of risk. Empirical evidence shows that the number of employees is negatively related to the stock returns (Lev and Thiagarajan, 1993; Abarbanell and Bushee, 1997, Seng and Hancock (2012). The current study argues that the condition in indonesia is slightly different compared to the United States. Larger number of employees is more related to better insurance of product continuity that could be associated with lower risk. So, a negative association between number of employees and stock returns is predicted.
The previously mentioned explanations lead us to propose the following hypothesis.
H4: Labor forcehas negative effect on the stock returns of manufacturing firm listed on Indonesian Stock Exchange.
Debt to equity ratio shows the company’s ability to meet the obligations upon its equity. The resulting analysis can help investors to assess the return that will be obtained in the future period. Debt to equity ratio shows the proportion between the amounts of long-term debtsand the amount of equity capital provided by the owner of the company. Larger debt equity ratio is interpretationthat the company’s financial performance is alarming, because the company is faced with higher debts to pay.Faced with this larger risk, investors would demand larger returns as a consequence for greater uncertainty of business they will encounter in the future. Empirical evidence shows mixed findings. That is, when Kebriaee-zadehet al. (2013) findpositive relation between debt to equity ratio and stock returns, Kennedy (2003) reports the opposite, i.e., a negative effect on stock returns.
Considering the results of existing theory and previous research, the proposed hypothesis is:
H5: Debt to equity ratio has positiveeffect on the stock returns of manufacturing firm listed on Indonesian Stock Exchange..
RESEARCH METHODS
This study uses secondary data in the form of annual financial reports published during 2010-2014 period generated from the Indonesia Stock Exchange website ( whilst the historical stock price data were extracted from The population of the study are manufacturing firms listed on the IDX during the period of 2010-2014. Total number of firms were 146 and after the selection of the samples, the number of usable samples were 47 firms. Table 1 presents the sample selection process.
Table 1. Sample Selection Proses
No / Description / Number of Firms1 / Manufacturing firm listed on BEI / 146
2 / Firms not listed consecutively or been delisted from IDX during the period of observation / (26)
3 / Firms with trading frequency of less than 100 transaction days each year / (51)
4 / Firms having corporate actions during period of analysis (performs a stock split and / or reverse stock split) / (16)
5 / Firms with no annual financial statements during the period of analysis / (6)
Firmssatisfy the criteria for sample selection / 47
The regression model used to test the hypotheses is shown in the following equation. Whist, the definition of each variable is described in Table 2.
Table 2 Name and Measurement of Variables
Symbol / Variable / MeasurementCAR / Cumulative abnormal return / The sum of monthly abnormal returns for one year
ITO / Inventory Turnover berbasis tahunan / Sales divided by average inventory
AR / Accounts Receivable Turnover / Account receivable divided by average daily sales, whilst average daily sales is measured as sales divided by 360 days
GPM / Gross Profit Margin / Gross profit divided by Sales
LF / Labor Force /
DER / Debt to Equity Ratio / Total liabilities divided by total equity
The cumulative abnormal return is measured using the single index model for estimation of expected returns. The single index model used in this study is based on the daily data over one year prior to the estimation of abnormal return. The following equations are used to estimate the cumulative abnormal returns for each company examined in this study.
E(Ri,t)= α +βRm,t+ Ɛ
where E(Ri)is expected return of firm i, αis a constant value, β is the sensitivity of market return movement over individual stock return, Rm,tis market return in which the proxy used to measure market return is the return of manufacturing index, and Ɛ is error term. Abnormal return is calculated using the following equation of which the return is based on monthly return.
ARi = Ri – E(Ri)
Where ARiis the abnormal return of stock i, Riis the real return of stock i, andE(Ri) is the expected return. All returns are calculated based on daily returns. The cumulative abnormal return is calculated using the following equation. The cumulative abnormal returns (CAR) for each company is based on monthly return over one year and is calculated using the following equation.
RESULTS AND DISCUSSION
The first analysis of the study is the descriptive statistics of each variable. The descriptive statistics of variables are presented in Table 3.
Table 3. Descriptive statistics of variables
Variable / Mean / Median / Minimum / Maximum / Standard DeviationCAR / 0.040 / -0.006 / -0.890 / 1.574 / 0.419
ITO / 5.541 / 5.345 / 0.458 / 12.146 / 2.382
AR / 51.794 / 47.414 / 4.505 / 119.603 / 25.448
GPM / 0.169 / 0.170 / -0.655 / 0.600 / 0.197
LF / -0.080 / -0.080 / -1.220 / 0.625 / 0.203
DER / 0.920 / 0.806 / -8.595 / 9.469 / 1.592
Note:
CAR (Cummulative Abnormal Return), ITO (Inventory Turnover), AR (Accounts Receivable Turnover), GPM (Gross Profit Margin), LF (Labor Force), DER (Debt to Equity Ratio).
The average CAR (cumulative abnormal returns) of the samples for 5 years is 4.00%. The standard deviation value is 41.9% which is greater than the average value. The value indicates that the CAR data is spreading from the average. The maximum value of 1.574 indicates that one firm was able to generate abnormal return of 157.4 percent a year.
The average ITO (inventory turnover) is 5.541 times per year. The standard deviation of 2.382 is smaller than 5.541 indicating that the data is gathered around the mean or close to the average. If we look more deeply, only one company that has the amount of inventory greater than the sales.
The AR (accounts receivable turnover) measured from the comparison between sales and accounts receivable of each company has an average of 51.79 times per year. The standard deviation of 25.45 is smaller than the mean of 51.79which means the data is gathered around the average and shows the level of the spread approaching the average value.
The average GPM (gross profit margin) measured from the ratio between gross profit and sales of each company is 16.9%. The standard deviation value of 19.7% is greater than the average of 16.9%. This indicates that gross profit margindata is having high variation. Some companies recorded loss during the period of analysis. A close examination shows that there are 39 data with negative gross profit margin.
Labor forcehas an average value of -8.00%. Maximum labor force value is 62.5%. Standard deviation value of 20.3% is greater than the average of -8.00% which means that labor force data spread or not close to the average. The negative value of average labor force indicate that many companies recorded decreasing sales compared to sales in the previous period. Thus, if labor force is regarded as an important factor on the determination of company value, the return generated by investors shall be negatively related with the level of labor force.
The average DER (debt to equity ratio) is 92.0%. The maximum value is9,469%. The standard deviation is159.2% which is greater than the average of 92.0%. There are 10 data where the debt to equity value is negative. This indicates that the company has negative equity in its balance sheet.
Results
Results of regression analysis is shown in Table 3. As depicted in Table 3, the results show that ITO and GPM have a significant positive effect on CAR while AR and LF have a significant negative effect on CAR. While DER has no effect on CAR.
Table 3. Results of Regression Analysis
Variable / Prediction / Regression Coefficient / t-value / ConclusionConstant / -0,095 / -1,097
ITO / Positive / 0,023 / 2,050 / Accept Hypothesis
AR / Positive / -0,002 / -2,380 / Reject Hypothesis
GPM / Positive / 0,492 / 3,711 / Accept Hypothesis
LF / Negative / -0,278 / -2,160 / Accept Hypothesis
DER / Positive / 0,032 / 1,957 / Accept Hypothesis
R2 =0.119; Adj. R2 = 0.099; F-stat = 6.171 (p=0.000), DW = 1.908
Note:
CAR (Cummulative Abnormal Return), ITO (Inventory Turnover), AR(Accounts Receivable Turnover), GPM (Gross Profit Margin), LF (Labor Force), DER (Debt to Equity Ratio), ** and ** denote coefficients are significant at 5% and 1%, respectively.