Firm size, earning yield, book to market ratio, cash flow yeild and stock returns: the napali evidence

Abstract

This study examines the relationship between four company fundamental variables (viz. size (market capitalization), book equity to market equity ratio, earning yield and cash flow yield) and equity returns in Nepali stock market. Alternative statistical specifications and various estimation methods are applied to a comprehensive, high-quality secondary data set of 92 listed firms in Nepal Stock Exchange that extends from July 2000 to July 2010 and primary data by taking opinion of investors, brokers and executives of listed companies through a structured questionnaire. The study also relates cross-sectional differences in returns on Nepalese stocks to the underlying behavior of four variables: earnings yield, size, book to market ratio, and cash flow yield and investigates whether the inclusion of any one or more of these fundamental variables can better explain cross sectional variations in equity returns in Nepal than the single factor CAPM. The study has found a statistically significant relationship between four company fundamentals: size (market capitalization), cash flow yield, book to market ratio and earning yield and stock returns in Nepal over the study period. This implies that a strong size effect, cash flow yield effect, and value effect existed in Nepali capital market during the study period. Since the results are not in support to the findings of the major studies done in the developed economies, this further implies that Nepali capital market is still in developing stage and investors needs to be very cautious while investing. The study finds that Fama French three factor model (viz. market risk premium, size premium and value premium) explains cross sectional variations in equity returns in Nepal in a much better way than the single factor CAPM. These results have important implications for market efficiency, asset pricing and market microstructure issues in Nepali stock market. Keywords: Stock Returns, Size Effect, Cash Flow Yield Effect, Value Effect