Financial Ratios and Stock Return Predictability (Evidence from Pakistan)

Abstract

The purpose of this research article is to investigate the ability of earning yield (EY), dividend yield (DY) and book-to-market ratio (B/M), to predict stock returns. The sample of the study consists of 100 non-financial companies listed in the “Karachi Stock Exchange”. The duration of the study is 7 years from 2005 to 2011. To find whether EY, DY and B/M ratios can predict stock returns we have used generalized least square and panal data models. The results indicate that DY and EY ratios has direct positive association with stock return where as B/M ratio has significant negative relationship with stock return. Therefore we can say that the above mentioned ratios are able to predict stock returns, furthermore it can be seen that as compare to dividend yield and earning yield the ratio of book to market has the highest predictive power. Moreover when we combine these financial ratios the predictability of stock returns will enhance.

Keywords: Financial ratios, Stock return, Karachi Stock Exchange, Dividend Yield, Earning Yield.