Firm Performance and Stock Returns: An Empirical Study of the Top Performing Stocks Listed on Shanghai Stock Exchange

Abstract

ABSTRACT This study attempts to determine whether and to what extent stock prices in the Chinese stock market are driven by firms' operating performance. We use a sample that consists of the top 10% performers listed in the Shanghai Stock Exchange from 1996 to 2000 in terms of annual stock returns. We use several measures to proxy for the firms' operating performance. Simple and multiple regressions are performed to determine, at the firm level, whether and to what extent these variables are related to stock price changes and what portion of the stock price movements can be explained by these firm performance variables. Our results indicate that while firm performance measures had some explanatory power of the stock price changes in the first two years during our testing period, the operating performance measures' explanatory power of the stock price movements generally declined as the stock prices went up. Our results suggest that the significant stock price increases from 1998 to 2000 were not driven by firms' operating performance. Instead, they were driven by several non-performance factors. INTRODUCTION The relationship between a firm's stock price movements and its operating performance has been a subject of considerable research interest in recent years but the results of the studies are not conclusive. Lamont (1998), Shiller (1984), Fama and French (1988), and Sivakumar and Waymire ((1993) find that the firm's operating performance can explain a significant portion of the stock price movements but Lev (1989) conducts a review of several studies on the information content of earnings and reports that earnings changes are only weakly related to contemporaneous stock returns and that the operating performance is not significantly related to contemporaneous stock returns. This paper extends this line of research into the Chinese stock market, which has experienced significant growth since the Shanghai Stock Exchange opened on Dec. 19, 1990. The purpose of the study is to determine whether and to what extent stock prices in the Chinese stock market are driven by firms' operating performance. This is of particular interest because the Chinese stock market is widely viewed as a very speculative, policy driven market. On the macro level, there appears to be a disconnect between the overall stock market returns and the GDP growth. From 1993 to 2003, the Shanghai Stock Exchange Composite Index experienced a cumulative increase of 79.53%, from 833.8 to 1497.04 (The annual returns of Shanghai Stock Exchange Index from 1991 to 2000 are presented in Table 1). But during the same time period, the real GDP increased from 3.46 trillion RMB to 11.66 trillion RMB, a cumulative increase of 236%. Clearly, the stock market has not been a good indicator of the macro economic development even though the number of listed companies in Shanghai Stock Exchange increased from 169 to 559 and the total trade volume increased from 64 billion shares to 231 billion shares from 1994 to 2000. In our study, we use a sample that consists of the top 10% performers listed in the Shanghai Stock Exchange from 1996 to 2000 in terms of annual stock returns. We use several measures to proxy for the firms' operating performance. These proxies are changes in earnings per share, changes in sales, profit margin, total asset turnover, returns on equity, and returns on assets. Simple and multiple regressions are performed to determine, at the firm level, whether and to what extent these variables are related to stock price changes and what portion of the stock price movements can be explained by these firm performance variables. Our results indicate that while firm performance measures had some explanatory power of the stock price changes in the first two years during our testing period, the operating performance measures' explanatory power of the stock price movements generally declined as the stock prices went up. Our results suggest that the significant stock price increases from 1998 to 2000 were not driven by firms' operating performance. …

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