Fundamental factors of Commercial banks

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A Study of

Factors investors consider while making fundamental analysis of

shares of commercial banks in Nepal

Submitted By

Sandarva Pal

A Graduate Research Report Submitted to

Ace Institute of Management

Pokhara University

Submitted for the degree of

Master of Business Administration

Kathmandu

December, 2012


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Acknowledgement

I am very grateful and genuinely thankful to all who helped me in my endeavor to

completing my research as well as production of this thesis. I would like to appreciate the

support from my classmates. I am also thankful to brokerage firms which I visited during

my survey.

In a special way, I am sincerely grateful to Mr. Sohan Babu Khatri, my thesis guide, for

providing me with tremendous guidance which proved to be invaluable in ensuring that this

research journey came to a triumphant end.


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Certificate of Authorship

I hereby declare that this submission is my own work and that, to the best of my

knowledge and belief, it contains no material previously published or written by

another person nor material which to a substantial extent has been accepted for the

award of any other degree of a university or other institution of higher learning,

expect where due acknowledgements.

Sandarva Pal


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Table of Contents

Chapter 1............................................................................................................................................... 1

Introduction........................................................................................................................................... 1

1.1 Background of the Study .......................................................................................................... 1

1.2 Statement of the Problem............................................................................................................ 3

1.3 Purpose of the Study ................................................................................................................... 4

1.4 Significance of the Study .................................................................................................... 4

1.5 Research Hypotheses .......................................................................................................... 5

1.6 Operational Definitions and Assumptions .................................................................................. 6

1.7 Organization of the Study ......................................................................................................... 12

1.8 Limitations of the study ............................................................................................................ 13

Chapter 2............................................................................................................................................. 14

Literature Review and Theoretical Framework.................................................................................. 14

2.1 Literature Review...................................................................................................................... 14

2.2 Theoretical Framework......................................................................................................... 21

Chapter 3............................................................................................................................................. 30

Research Methodology ....................................................................................................................... 30

3.1 Research Plan and Design......................................................................................................... 30

3.2 Description of the Sample and Sampling technique ................................................................. 31

3.3 Instrumentation ......................................................................................................................... 32

3.4 Method of Analysis................................................................................................................... 33

3.5 Data Collection Procedure and Time Frame ............................................................................. 33

3.6 Validity and Reliability............................................................................................................. 34

3.7 Overall Analysis Plan ............................................................................................................... 35

Chapter 4............................................................................................................................................. 36

Results and Discussion ....................................................................................................................... 36

4.1 Presentation of Results and Descriptive Analysis..................................................................... 36

4.1.1 Demographic Factors Analysis .......................................................................................... 36

4.1.2 General information analysis ............................................................................................. 38

4.2 Types of Statistical Tests Performed ........................................................................................ 40


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4.3 Inferential Analysis and Discussion.......................................................................................... 43

4.3.1 Cross tabulation Analysis .................................................................................................. 43

4.3.1.1 Cross tabulation between Age group of investors and Ideology of political party in

government factor considered ..................................................................................................... 43

4.3.1.2 Cross tabulation between Age group of investors and Impact of regulation & policiesfactor considered......................................................................................................................... 44

4.3.1.3 Cross tabulation between Age group of investors and Corporate governance factor

considered ................................................................................................................................... 45

4.3.1.4 Cross tabulation between Age group of investors and Liquidity position factor

considered ................................................................................................................................... 46

4.3.1.5 Cross tabulation between Age group of investors and Capital adequacy factor considered

.................................................................................................................................................... 46

4.3.1.6 Cross tabulation between Age group of investors and Earning per share factor

considered ................................................................................................................................... 47

4.3.1.7 Cross tabulation between Age group of investors and Interest spread factor considered48

4.3.1.8 Cross tabulation between Age group of investors and Cost of fund factor considered .. 49

4.3.1.9 Cross tabulation between Age group of investors and Profitability factor considered ... 50

4.3.1.10 Cross tabulation between Age group of investors and Loan portfolio size factor

considered ................................................................................................................................... 51

4.3.1.11 Cross tabulation between Age group of investors and Loan loss provision factor

considered ................................................................................................................................... 52

4.3.1.12 Cross tabulation between Age group of investors and Dividend history factor

considered ................................................................................................................................... 53

4.3.1.13 Cross tabulation between Age group of investors and Size of deposit factor considered

.................................................................................................................................................... 54

4.3.1.14 Cross tabulation between Age group of investors and Non-performing loan factor

considered ................................................................................................................................... 55

4.3.1.15 Cross tabulation between Age group of investors and Number of branches factor

considered ................................................................................................................................... 56

4.3.1.16 Cross tabulation between Age group of investors and Management team factor

considered ................................................................................................................................... 57

4.3.1.17 Cross tabulation between Age group of investors and Directors in Board factor

considered ................................................................................................................................... 58

4.3.1.19 Cross tabulation between Age group of investors and Years of operation factor

considered ................................................................................................................................... 60

4.3.1.20 Cross tabulation between Education Level of investors and Ideology of political party

in government factor considered................................................................................................. 61


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4.3.1.21Cross tabulation between Education Level of investors and Impact of regulation &

policies factor considered ........................................................................................................... 62

4.3.1.22 Cross tabulation between Education Level of investors and Corporate governance

factor considered......................................................................................................................... 63

4.3.1.23 Cross tabulation between Education Level of investors and Liquidity position factorconsidered ................................................................................................................................... 64

4.3.1.24 Cross tabulation between Education Level of investors and Capital adequacy factor

considered ................................................................................................................................... 65

4.3.1.25 Cross tabulation between Education Level of investors and Earning per share factor

considered ................................................................................................................................... 66

4.3.1.26 Cross tabulation between Education Level of investors and Interest spread factor

considered ................................................................................................................................... 67

4.3.1.27 Cross tabulation between Education Level of investors and Cost of fund factor

considered for fundamental analysis of shares of commercial banks ......................................... 68

4.3.1.28 Cross tabulation between Education Level of investors and Profitability factor

considered ................................................................................................................................... 69

4.3.1.29 Cross tabulation between Education Level of investors and Loan portfolio size factor

considered ................................................................................................................................... 70

4.3.1.30 Cross tabulation between Education Level of investors and Loan loss provision factor

considered ................................................................................................................................... 71

4.3.1.31 Cross tabulation between Education Level of investors and Dividend history factor

considered ................................................................................................................................... 72

4.3.1.32 Cross tabulation between Education Level of investors and Size of deposit factor

considered ................................................................................................................................... 73

4.3.1.33 Cross tabulation between Education Level of investors and Non-performing loan factor

considered ................................................................................................................................... 74

4.3.1.34 Cross tabulation between Education Level of investors and Number of branches factor

considered ................................................................................................................................... 75

4.3.1.35 Cross tabulation between Education Level of investors and Management team factor

considered ................................................................................................................................... 76

4.3.1.36 Cross tabulation between Education Level of investors and Directors in Board factor

considered ................................................................................................................................... 77

4.3.1.37 Cross tabulation between Education Level of investors and Overall image of

bank/brand name factor considered ............................................................................................ 78

4.3.1.38 Cross tabulation between Education Level of investors and years of operation factor

considered ................................................................................................................................... 79

4.3.2 Intra-Industry/Company factor analysis............................................................................. 80


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4.3.2.1 Intra-industry factor ranking by different age group of investors when market is bearish

.................................................................................................................................................... 80

4.3.2.2Intra-company factor ranking by different age group of investors when market is bullish

.................................................................................................................................................... 81

4.3.2.3 Intra-company factor ranking by different income level investors when market is bearish.................................................................................................................................................... 83

4.3.3ANOVA test........................................................................................................................ 84

4.3.4 Chi-square test ................................................................................................................. 102

4.3.4.1 Test of significant association between age group of investors and their consideration of

ideology of political party in government as a factor for fundamental analysis of shares of

commercial banks ..................................................................................................................... 102

4.3.4.2 Test of significance association between age group of investors and their consideration

of liquidity position as a factor for fundamental analysis of shares of commercial banks ....... 102


profitability as a factor for fundamental analysis of shares of commercial banks .................... 103


management team as a factor for fundamental analysis of shares of commercial banks .......... 104

4.3.4.5 Test of significant association between education level of investors and their

consideration of ideology of political party in government as a factor for fundamental analysis

of shares of commercial banks .................................................................................................. 104


consideration given to liquidity position as a factor for fundamental analysis of shares of



consideration given to profitability as a factor for fundamental analysis of shares of commercial

banks ......................................................................................................................................... 106


consideration given to management team as a factor for fundamental analysis of shares of


4.3.4.9 Test of significant association between income level of investors and their consideration

given to ideology of political party in government as a factor for fundamental analysis of shares

of commercial banks ................................................................................................................. 1074.3.4.10 Test of significant association between income level of investors and their

consideration given to liquidity position as a factor for fundamental analysis of shares of


4.3.4.11 Test of significant association between income level of investors and their

consideration given to profitability as a factor for fundamental analysis of shares of commercial

banks ......................................................................................................................................... 108


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4.3.4.12 Test of significant association between income level of investors and their

consideration given to management team as a factor for fundamental analysis of shares of


Chapter 5........................................................................................................................................... 110

Summary and Conclusions ............................................................................................................... 1105.1 Summary of findings............................................................................................................... 110

5.2 Conclusions............................................................................................................................. 116

5.3 Recommendations............................................................................................................... 117

Bibliography ...................................................................................................................................... 119

List of Tables

Table 1: Frequency distribution based on age group of respondents.................................................. 36

Table 2: Frequency distribution based on education level of respondents ......................................... 36

Table 3: Frequency distribution based on profession of respondents ................................................. 37

Table 4: Frequency distribution based on average monthly income of respondents .......................... 37

Table 5: Frequency distribution based on investment horizon of respondents ................................... 38

Table 6: Frequency distribution based on response to research report published by individuals and

institutions........................................................................................................................................... 38

Table 7: Frequency distribution based on response to recommendations/suggestions from brokers . 39

Table 8: Frequency distribution based on response to investment management service providers .... 39

Table 9: Frequency distribution based on response to selfresearch.................................................. 39

Table 10: Frequency distribution based on response to research web sites ........................................ 39

Table 11: Frequency distribution based on response to news papers ................................................. 40

Table 12: Frequency distribution based on response to tips from relatives/friends ............................ 40

Table 13: Cross tabulation between Age group of investors and Ideology of political party in

government factor considered while making fundamental analysis of shares of commercial banks.. 43

Table 14: Cross tabulation between Age group of investors and Impact of regulation & policies

factor considered while making fundamental analysis of shares of commercial banks ...................... 44

Table 15: Cross tabulation between Age group of investors and Corporate governance factor

considered while making fundamental analysis of shares of commercial banks ................................ 45

Table 16: Cross tabulation between Age group of investors and Liquidity position factor considered

while making fundamental analysis of shares of commercial banks .................................................. 46


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Table 17: Cross tabulation between Age group of investors and Capital adequacy factor considered


Table 18: Cross tabulation between Age group of investors and Earning per share factor considered


Table 19: Cross tabulation between Age group of investors and Interest spread factor considered


Table 20: Cross tabulation between Age group of investors and Cost of fund factor considered while

making fundamental analysis of shares of commercial banks ............................................................ 49

Table 21: Cross tabulation between Age group of investors and Profitability factor considered while

making fundamental analysis of shares of commercial banks ............................................................ 50

Table 22: Cross tabulation between Age group of investors and Loan portfolio size factor considered


Table 23: Cross tabulation between Age group of investors and Loan loss provision factor


Table 24: Cross tabulation between Age group of investors and Dividend history factor considered


Table 25: Cross tabulation between Age group of investors and Size of deposit factor considered


Table 26: Cross tabulation between Age group of investors and Non-performing loan factor


Table 27: Cross tabulation between Age group of investors and Number of branches factor


Table 28: Cross tabulation between Age group of investors and Management team factor considered

while making fundamental analysis of share commercial banks ........................................................ 57

Table 29: Cross tabulation between Age group of investors and Directors in Board factor considered


Table 30: Cross tabulation between Age group of investors and Overall image of bank/brand name

factor considered while making fundamental analysis of shares of commercial banks ...................... 59Table 31: Cross tabulation between Age group of investors and Years of operation factor considered


Table 32: Cross tabulation between Education Level of investors and Ideology of political party in

government factor considered while making fundamental analysis of shares of commercial banks.. 61


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Table 33: Cross tabulation between Education Level of investors and Impact of regulation & policies

factor considered while making fundamental analysis of shares of commercial banks ...................... 62

Table 34: Cross tabulation between Education Level of investors and Corporate governance factor


Table 35: Cross tabulation between Education Level of investors and Liquidity position factor


Table 36: Cross tabulation between Education Level of investors and Capital adequacy factor


Table 37: Cross tabulation between Education Level of investors and Earning per share factor


Table 38: Cross tabulation between Education Level of investors and Interest spread factor


Table 39: Cross tabulation between Education Level of investors and Cost of fund factor considered


Table 40: Cross tabulation between Education Level of investors and Profitability factor considered


Table 41: Cross tabulation between Education Level of investors and Loan portfolio size factor


Table 42: Cross tabulation between Education Level of investors and Loan loss provision factor


Table 43: Cross tabulation between Education Level of investors and Dividend history factor


Table 44: Cross tabulation between Education Level of investors and Size of deposit factor


Table 45: Cross tabulation between Education Level of investors and Non-performing loan factor


Table 46: Cross tabulation between Education Level of investors and Number of branches factor

considered while making fundamental analysis of shares of commercial banks ................................ 75Table 47: Cross tabulation between Education Level of investors and Management team factor


Table 48: Cross tabulation between Education Level of investors and Directors in Board factor



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Table 49: Cross tabulation between Education Level of investors and Overall image of bank/brand

name factor considered while making fundamental analysis of shares of commercial banks ............ 78

Table 50: Cross tabulation between Education Level of investors and Years of operation factor


Table 51: Intra-industry factor ranking by different age group of investors when market is bearish. 80

Table 52: Intra-company factor ranking by different age group of investors when market is bullish 81

Table 53: Intra-company factor ranking by different income level investors when market is bearish83

Table 54: Anova test for difference in the mean consideration given to industry factors between

different age group of investors with long investment horizon .......................................................... 85


different age group of investors with short investment horizon ......................................................... 85


different age group of investors when market is bullish ..................................................................... 86


different age group of investors when market is bearish .................................................................... 87

Table 58: Anova test for difference in the mean consideration given to company factors between

different age group of investors with long investment horizon .......................................................... 87


different age group of investors with short investment horizon ......................................................... 88


different age group of investors when market is bullish ..................................................................... 89


different age group of investors when market is bearish .................................................................... 89


different education level investors with long investment horizon ...................................................... 90


different education level investors with short investment horizon ..................................................... 91

Table 64: Anova test for difference in the mean consideration given to industry factors betweendifferent education level investors when market is bullish ................................................................. 91


different education level investors when market is bearish ................................................................ 92


different education level investors with long investment horizon ...................................................... 93


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different education level investors with short investment horizon ..................................................... 94


different education level investors when market is bullish ................................................................. 94


different education level investors when market is bearish ................................................................ 95


different income level investors with long investment horizon .......................................................... 96


different income level investors with short investment horizon ......................................................... 97


different income level investors when market is bullish..................................................................... 98


different income level investors when market is bearish .................................................................... 98


different income level investors with long investment horizon .......................................................... 99


different income level investors with short investment horizon ....................................................... 100


different income level investors when market is bullish................................................................... 100


different income level investors when market is bearish .................................................................. 101

Table 78: Chi-square test between age group of investors and their consideration of ideology of

political party in government factor while making fundamental analysis of shares of commercial

banks ................................................................................................................................................. 102

Table 79: Chi-square test between age group of investors and their consideration of liquidity position

factor while making fundamental analysis of shares of commercial banks ...................................... 103

Table 80: Chi-square test between age group of investors and their consideration of profitabilityfactor while making fundamental analysis of shares of commercial banks ...................................... 103

Table 81: Chi-square test between age group of investors and their consideration of management

team factor while making fundamental analysis of shares of commercial banks ............................. 104

Table 82: Chi-square test between education level of investors and their consideration of ideology of


banks ................................................................................................................................................. 105


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Table 83: Chi-square test between education level of investors and liquidity position factor

considered while making fundamental analysis of shares of commercial banks .............................. 105

Table 84: Chi-square test between education level of investors and their consideration of profitability

factor while making fundamental analysis of shares of commercial banks ...................................... 106

Table 85: Chi-square test between education level of investors and management team factor

considered while making fundamental analysis of shares of commercial banks .............................. 107

Table 86: Chi-square test between income level of investors and their consideration of ideology of


banks ................................................................................................................................................. 107

Table 87: Chi-square test between income level of investors and their consideration of liquidity

position factor while making fundamental analysis of shares of commercial banks ........................ 108

Table 88: Chi-square test between income level of investors and their consideration of profitability

factor while making fundamental analysis of shares of commercial banks...................................... 109

Table 89: Chi-square test between income level of investors and their consideration of management

team factor while making fundamental analysis of shares of commercial banks ............................. 109

List of Figure

Figure 1: Theoretical Framework....................................................................................................... 21


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Executive Summary

Fundamental analysis is a major technique to correctly estimate the price of a share of any

bank and financial institution. Investors have been using fundamental analysis along with

technical to predict the price of share. The choice of fundamental factor for calculating the

stock price depends on age, education and other demographic variables of investor.

Numerous studies have shown that with age (or experience) and education comes the ability

to segregate relevant and important economy, industry and company factors.

This study was an endeavor to get insight into what key fundamental factors investors think

is most important for investing in shares of commercial banks. Which factors they consider

is most valuable for calculating and predicting the share price of commercial bank. For this

purpose 120 samples was chosen taking 30 samples for each sub-variable under education

level variable. Small pilot study was undertaken to identify fundamental factors where only

industry and company factors identified as important. Accordingly, a survey questionnaire

was developed by dividing factors under industry and company factors. Investors rated the

factors in five rating scale. The purpose of the study is to identify which fundamental factors

are important to share traders of commercial bank with long and short investment horizon

and under bullish and bearish market trend. And test relationship between demographicvariable of respondents and factors considered by them. Investors have been divided into

five categories. Here, only age, education and income level variables are taken into account

for this study purpose.

Fundamental Share prices are the most important indicator readily available to the investors

for their decision to invest or not in a particular share. Theories suggest that share price

changes is associated with changes in fundamental variables which are relevant for share

valuation like payout ratio, dividend yield, capital structure, earnings size of the firm and its

growth. In effect in investors are always mindful of the macroeconomic and microeconomic

variables in analyzing investment in stock as they effect the performance of and turnover of

banks, return of investors by way of dividend


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This study also tests whether factors like ideology of political party in government, liquidity

position; profitability and management team as factors for fundamental analysis have

significant relationship with age, education and income level of investors in Nepalese

context where it has been shown significant relation in international studies.

Descriptive and inferential analysis was used to get some meaningful understanding from

the research. Mean rating of all factors are calculated for using ANOVA test statistics

analysis and four key factors among nineteen factors are taken to test significant relationship

using Chi-square test analysis has shown somewhat opposite relationships compared to other

research findings in international context

The findings of the study showed that Nepalese investors have increasingly becoming aware

of need to carry fundamental analysis before investing in shares of commercial bank. Also it

showed that investors do lot of self-research while making fundamental analysis of shares of

commercial banks. However, the finding that age, education and income level factor does

not influence the consideration given to fundamental factors is quite surprising. This can be

a starting point for other researchers on exploring why such relationship was shown in this

study. Female investors are almost none in Nepalese capital market.

From this study it can be concluded that Nepalese investors give priority to both industry

and company factors regardless of their investment horizon and market trend . In recent

years lots of changes has occurred where investors are more educated, knowledgeable and

study the industry and company variables before making investment in shares of commercial

banks. Fundamental analysis have become a main technique for Nepalese investors to decide

when to invest in share of commercial banks


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Chapter 1

Introduction

1.1 Background of the Study

Investment in the shares of banks and financial institutions occupy a major portion of the

Nepalese capital markets (Bajracharya, 2004).Banks share price is the result of combined

effect of changes in economy, industry and company fundamentals (Karpagavalli, 2011).

The combined fundamental factors i.e. economic, industry and company determine the

return in investment of shares of commercial banks (Kevin, 2001). Fundamental analysis is a

systematic approach for determining the future dividends and share price of a security based

on the premise that share price behavior is influenced by fundamental factors

(Abdolahzadeh, 2002). Each share is assumed to have an economic worth based on its

present and future earning capacity called intrinsic value or fundamental value. The investor

can make use of available information and examine related fundamental factors and then

arrive at an investment decision.

Fundamental Share prices are the most important indicator readily available to the investors

for their decision to invest or not in a particular share. Theories suggest that share price

changes is associated with changes in fundamental variables which are relevant for share

valuation like payout ratio, dividend yield, capital structure, earnings size of the firm and its

growth,[Wilcox (1984), Rappoport (1986), Downs (1991)]. In effect in investors are always

mindful of the macroeconomic and microeconomic variables in analyzing investment in

stock as they effect the performance of and turnover of banks, return of investors by way of

dividend

Fundamental analysis, unlike technical analysis, is more powerful tool to find the intrinsic

value of stock for both bullish and bearish trend (Linter, 1956). Investors with long and short

investment horizon are likely to choose or give priority to fundamental factors differently

(Hamada 1972).


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Study of fundamental factors used by investors in trying to come up with fair value of share

of bank shows investors with varying attributes tend to select and give importance to

specific company and industry factor in rather distinctive way making the fundamental

analysis unique to each individual (Ariff and Khan, 2000).

The fundamental factors relevant to banking industry are divided into three groups:

Company factor: e.g. profit, management team, liquidity Incomes, loan size etc.

financial power, products, management and workforce relations

Industrial conditions: e.g. stability and current competitive situation, central bank

directives and policies

Economy/market conditions: economic cycles and Money and Financial Policies of the

Country (Raei, 2010)

Several studies have attempted to identify company specific and industry fundamental

variables which explain variations in common stock return. Investors give importance to

fundamental factors based on their investment horizon, market trend and overall economic

and political situation of the country. This attempt to include factor or variable in their

analysis of shares of banks leads an investor to constantly review their selection of factors

with regard to changes in time and situation. Individuality plays vital role in determining

with factor to consider superior and which one as inferior for fundamental analysis (Jonz,

2002).

In the context of Nepal, Nepalese investors largely comprised of passive investors who

would buy shares during IPO and sell shares with no consideration to market conditions

(Pradhan, 2011). Dangol (2010) concluded in his research that majority of the investors are

not well informed, they mostly go by market whims rather that market fundamentals while

investing in stocks of banks and other sector. However, in recent decades the trading in

shares of Nepalese firms and specifically that of commercial banks has become a profession

on its own. There are altogether 58 brokers where professionals trade actively using

fundamental and technical analysis as a tool to find the correct price at which profit can be

made.

This study has attempted to understand what key fundamental factors are important to

Nepalese investors in determining selection and investment in shares of commercial banks.


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Moreover, it attempts to understanding whether consideration or choice of industry and

company factors changes with change in demographics of investor. Here age, education

level and income level are taken as key demographic attributes of investors.

Most of the Nepalese researchers have used fundamental variables based on their knowledge

and sometime arbitrarily too while studying fundamental analysis done by investors in

shares of firms listed in NEPSE. This study has figured out key industry and company

factors based on pilot study using convenience sampling method.

1.2 Statement of the Problem

Most of the researchers have devoted significant effort in trying to figure out relationship

between stock return and fundamental variables. This is true in Nepalese context as well.

Literature review on role of fundamental analysis in determining stock return is plenty in

both national and international journals.

In Nepalese context, the review of previous research studies shows that there lacks proper

study of what fundamental factors are investors actually considering while making

fundamental analysis of stocks of commercial banks. The researchers have primarily

focused on determining stock return based on implicit fundamental variables (SushmaPradhan (2011). Most of the Nepalese researchers have used fundamental variables on their

research based on their knowledge and sometime arbitrarily too while studying fundamental

analysis done by investors in shares of firms listed in NEPSE which is true to fundamental

analysis of commercial banks.

In the existing studies there exist many gaps such as that there may be difference of opinion

with use of fundamental factors when it comes to different age group of people, occupations

and educational level and income in the stock market. Another gap that exists is what factorsinvestors consider when investing for long term and short term and while taking positions in

bearish or bullish trend market in stock of commercial bank.

No papers in the literature (I am aware of) examine (using primary survey) exactly what

factors investors consider for fundamental analysis of shares of commercial banks in Nepal.


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1.3 Purpose of the Study

This research aims to find out following aspects of Nepalese investors choice of

fundamental factors while making analysis of stocks of commercial bank traded in NEPSE

To determine which industry and company factors investors consider the most whilemaking fundamental analysis of stocks of commercial banks

To determine how rating of industry and company factors changes with change ininvestors investment horizon (long and short horizon)

To determine how investors rate factors for bullish and bearish market trend To determine the relationship between investors demographic profile and factors

considered for fundamental analysis

1.4Significance of the StudyThere has been long belief that most of the investors are passive investors who trade in

stocks based on rumors and influences by others. This to very extent can be generalized to

those investors who mainly buy shares during IPO. By focusing entirely on those investors

who are members with brokers and are well informed about the changes in industry and

company variables of banks this study will explore those key fundamental factors that has

proven to be useful to predict the share price movement. Thus, can be a useful resource for

investment analysts, share brokers and new comers in the capital market to get insight into

what factors are most relevant and suitable for analyzing the share price of commercial

banks. And which new industry and company factors have become important with time and

practice of investing in shares of commercial banks

This study can prove to be useful for policy makers as well since it will explore the current

trend in investment in bank shares and level of knowledge with which they start their trading

and source of information investors consider worth for making fundamental analysis. Here

policy makers can find ways to make trading more transparent and disseminate information

in the most effective way about financial markets and trading.

There has been lot of study on how fundamental variables affect the stock return in Nepalese

stock market but rarely on what fundamental variables investors choose while doing

fundamental analysis of stocks of commercial banks. This study aims to identify major


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variables investors take into consideration and among such variables which factors are most

important with regard to market situation and their investment horizon. This study will

provide a guideline to other researchers and students on understanding Nepalese investors

choice of fundamental variables and how it affects their analysis of stocks of commercial

banks

1.5Research Hypotheses

a) H0: There is no statistically significant difference in the mean consideration given toindustry factors between different age group of investors:

i. With long or short investment horizon

ii. When market is bullish or bearish

b) H0: There is no statistically significant difference in the mean consideration given tocompany factors between different age group of investors



c) H0: There is no statistically significant difference in the mean consideration given toindustry factors between different education level investors



d) H0: There is no statistically significant difference in the mean consideration given tocompany factors between different education level investors




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e) H0: There is no statistically significant difference in the mean consideration given toindustry factors between different income level investors



f) H0: There is no statistically significant difference in the mean consideration given tocompany factors between different income level investors



g) H0: There exists no significant association between age group of investors and theirconsideration of ideology of political party in government, liquidity position,

profitability and management team as factors for fundamental analysis of shares of

commercial banks

h) H0: There exists no significant association between education level of investors andtheir consideration of ideology of political party in government, liquidity position,


commercial banks

i) H0: There exists no significant association between income level of investors andtheir consideration of ideology of political party in government, liquidity position,


commercial banks

1.6 Operational Definitions and Assumptions

Shares: A share is a single unit of ownership in a corporation, mutual fund, or any

other organization. A joint stock company divides its capital into shares, which are offered

for sale to raise capital, termed as issuing shares. Thus, a share is an indivisible unit of

capital, expressing the proprietary relationship between the company and the shareholder.


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The denominated value of a share is its face value: the total capital of a company is divided

into a number of shares. For this research purpose the term share means unit of ownership in

commercial banks of Nepal.

Commercial Bank: A financial institution that provides services, such as accepting

deposits, giving business loans and auto loans, mortgage lending, and basic investment

products like savings accounts and certificates of deposit. The traditional commercial bank

is a brick and mortar institution with tellers, safe deposit boxes, vaults and ATMs. However,

some commercial banks do not have any physical branches and require consumers to

complete all transactions by phone or Internet. In exchange, they generally pay higher

interest rates on investments and deposits, and charge lower fees. Here, for the research

purpose commercial banks mean all the 32 commercial banks registered and licensed by

Nepal Rastra Bank.

Fundamental Analysis: Fundamental analysis is the examination of the underlying forces

that affect the well-being of the economy, industry groups, and companies. As with most

analysis, the goal is to derive a forecast and profit from future price movements. At the

company level, fundamental analysis may involve examination of financial data,

management, business concept and competition. At the industry level, there might be an

examination of supply and demand forces for the products offered. For the national

economy, fundamental analysis might focus on economic data to assess the present and

future growth of the economy. To forecast future stock prices, fundamental analysis

combines economic, industry, and company analysis to derive a stock's current fair value

and forecast future value. If fair value is not equal to the current stock price, fundamental

analysts believe that the stock is either over or under valued and the market price will

ultimately gravitate towards fair value.

Industry Factors: Industry factors are those factors present in the external environment ofthe bank and influence the performance of the bank. Here key industry factors are ideology

of political party in government, impact of regulation & policies, corporate governance,

liquidity position


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Industry factors included in this study are:

1. Ideology of political party in government

A political ideology is a coherent and consistent set of beliefs about who ought to rule, what

principles rulers ought to obey, and what policies rulers ought to pursue. Whether people

have a political ideology can be measured in two ways: (1) by seeing how frequently people

speak in terms of broad political categories-liberal or conservative-when they discuss

politics; and (2) by measuring the extent to which we can predict a person's view on one

issue by knowing his or her view on another issue

2. Impact of regulation and policies

Policy consists of regulation and control over the growth of money and credit in an attempt

to pursue broad economic goals such as full employment, avoidance of inflation, and

sustainable economic growth. Its principal tools are Open-Market Policy Tool, Discount

Rate Policy, Changing Reserve Requirements on Deposits and Other Bank Liabilities. These

tools aim at keeping unemployment low, inflation low and to ensure high economic growth.

3. Corporate governance

The corporate governance is to facilitate effective, entrepreneurial and prudent management

that can deliver the long-term success of the company. It is based on the underlying

principles of all good governance: accountability, transparency, probity and focus on the

sustainable success of an entity over the longer term.

4. Liquidity position

The term liquidity signifies financial flows of various kinds, ranging from that originating

from the central bank to the overall existent financing available in the banking system.

Eventually liquidity is determined by the net change in the bank reserves through interaction

among the various autonomous factors that drive liquidity and its management by the

Reserve Bank. To that extent, the daily outstanding position in the Liquidity Adjustment

Facility (LAF) emerges as the key indicator of the funding available in the system


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Company factors: Company (bank) factors are those factors which are directly related to

the bank. These factors are major indicator of banks performance. Here key company

factors are capital adequacy, earning per share, Interest spread, cost of fund, profitability,

loan portfolio size, loan loss provision, dividend history, size of deposit, non-performing

loan, number of branches, management Team, Directors in Board, Overall image of

bank/brand name, years of operation

Company factors included in this study are:

1. Capital adequacy

Capital adequacy is intended to ensure that banks maintain a minimum amount of own funds

in relation to the risks they face so that banks are able to absorb unexpected losses. Adequate

capital ensures that unanticipated situation does not present any serious challenge to banks

solvency

2. Earning per share

It is the rupee earning for each share where relation of earning (net income) to equity

investment is determined. It calculated as net income divided by number of shares

outstanding.

3. Interest spread

It shows the additional cost of borrowing that the banks take on to perform intermediation

activities between borrowers and fund lenders. I is also a premium for the risk that the banks

undertake; it compensates for loan defaults and for risk related to cost of funding.

4. Cost of fund

The interest rate paid by financial institutions for the funds that they deploy in their

business. The cost of funds is one of the most important input costs for a financial

institution. For lenders such as banks and credit unions, cost of funds is determined by the

interest rate paid to depositors on financial products including savings accounts and time

deposits.


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5. Profitability

Banks profit by earning more money than what they pay in expenses. The major portion of a

bank's profit comes from the fees that it charges for its services and the interest that it earns

on its assets. Its major expense is the interest paid on its liabilities. The traditional measures

of the profitability of any business are it return on assets (ROA) and return on equity (ROE).

6. Loan portfolio size

It is the Total of all loans held by a bank or finance company on any given day. Loans that

a lender (or a buyer of loans) is owed. The loan portfolio is listed as an asset on the lender's

or investor's balance sheet. The value of a loan portfolio depends on both

the principal and interest owed and the average creditworthiness of the loans.

7. Loan loss provision

The loan loss provision account is a contra-asset account, which reduces the loans by the

amount the banks managers expect to lose when some portion of the loans are not repaid.

Periodically, the banks managers decide how much to add to the loan loss reserves account,

and charge this amount against the banks current earnings. This provision for loan losses

is recorded as an expense item on the banks income statement to absorb losses when

economic conditions worsen.

8. Dividend history

Dividends are income tax free in the hands of the recipient. The profit earned by the

Company (after payment of Corporate Income-tax) can either be retained in the

Company for its future financial needs or distributed to shareholders in the form of dividend.

According to the Companies Act, 1956, after satisfying the rights of preference shares, the

equity shares shall be entitled to share in the remaining amount of distributable profits of the

company. Dividend history usually refers to the frequency of dividend distribution paid in

the companys history and its dividend payout ratio.


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9. Size of deposit

Banks accepts deposits from its customers (depositor). The amount of cash deposit collected

and retained in the bank at a particular period of time determines the size of deposit. Size of

deposit determines banks cost of fund and on the other its liquidity position (or lending

capacity)

10. Non-performing loan

Non-performing loans (NPLs) have been widely used as a measure of the asset quality

among lending institutions and are often associated with their failures and financial crises. It

can be defined as an advance where payment of interest or repayment of installment of

principal or both remains unpaid for a period of two quarters or more.

11. Number of branches

It is the number of banking outlets opened in the various geographical areas to facilitate the

banking access to customers within and/or outside the country.

12. Management team

The composition of top, middle and lower level managers and staffs who are directlyinvolved in the day to operation of the company and have duties and responsibilities to

fulfill. For bank it accounts for all the staffs work for bank in providing financial services to

customers

13. Directors in Board

Typically, a board includes individuals who are bank officers or employeescalled

management or inside directorsand outside directors who are neither officers nor

employees of the bank. Outside, independent2

directors bring experiences from their fields of

expertise. These experiences provide perspective and objectivity as the director oversees

bank operations and evaluates management recommendations.


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14. Overall image of bank

It is the perception created in the minds of the stakeholders through its operation, services

and other activities. A positive image of a bank is created when bank follows guidelines of

regulator, provides transparency in financial activities and satisfies all its stakeholders

without affecting each others interest and provides distinct services to its customers

15. Years of operation

It is the years of operation in the business continuously. Organization with long history of

presence in the business is usually easily recognized by people and a reputation is build

based on its years of operation and service.

1.7 Organization of the Study

The study is organized into a total of five chapters.

Chapter one: Introduction

It contains background of the study including statement of the problem, purpose of the

study, significance of the study, research questions, operational definitions and assumptions,

organization of the study and limitation of the study

Chapter two: Literature Review and Theoretical Framework

It consists of literature review and theoretical framework related to international studies as

well as the review of studies in Nepalese context. Besides, this chapter ends up with

concluding remarks associated to the findings and major ideas of national and international

studies.

Chapter three: Research Methodology

It covers the research plan and design, description of the sample and sampling technique

which includes nature and sources of data and technique used to collect data. It also consists

of instrumentation, method of analysis, data collection procedure and time, validity and

reliability of method used and overall analysis plan.


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Chapter four: Results and Discussion

It basically focuses on the systematic presentation and analysis of the data and interpretation

and discussion associated with the major findings of the study. This chapter is further

divided into two sections, namely, analysis of primary data using descriptive and analytical

analysis

Chapter five: Summary and Conclusion

This chapter provides a summary of overview on all works carried out in chapter one

through four including major conclusions derived from the study that are consistent or

contradicted with past studies. This chapter also includes a separate section for

recommendations about selection of variables, study period and such that are expected to be

beneficial to students, investors and researchers for the further studies

1.8 Limitations of the study

Limitations occur in every research work and this research also has some limitations. The

limitations of the study are as follows:

Time: There is need to complete the research within three months. This leaves theresearcher with inadequate time to deal every aspect of the issues of the topic in

details. Thus, this research will not cover everything but focus on limited issues. This

research is limited in its scope.

Cost: This is a self-financed research. That means, the researcher will have to bearall the cost of conducting the research. So the researcher has to work with limited

budget making the hiring of specialists and other manpower to collect and analyze

data and its management is not possible. Availability of Data: This type of research would have to depend heavily on

primary source of data. Thus, availability of secondary data is expected to be limited.

Manpower: The researcher has to work on his own. Collection of data, interview ofpeople, preparation of report and such has to be done by the researcher himself. The


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researchers lack of knowledge in any area/ subject can reduce the quality of the

research outcome

Chapter 2

Literature Review and Theoretical Framework

2.1 Literature Review

Graham and Dodd (1934) studied the origin and importance of fundamental analysis for the

share price valuation. The authors have argued the importance of the fundamental factors for

investors while making investment decisions in stocks of financial institutions


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Osaze (1985) identified corporate earnings and dividends as key company fundamentals that

were highly taken into account by share traders of banks and financial institutions. He

pointed that intrinsic value of share of bank depends on declaration of earnings and dividend

payout ratio by banks. This too determined how investors hold the shares of bank.

Negy and Obenberger (1994) examined the factors influencing individual investor behavior

in considering which fundamental factors are important for banks share analysis. The

researchers distributed a list containing 34 affecting variables on decision making among the

shareholders of listed companies largely comprising of banks and financial institutions. The

findings show a combination of financial and nonfinancial factors. According to these

findings, one can conclude that investors decisions include a continuum of financial and

nonfinancial items that each investor may consider a different importance for each factor.

The result of the study showed that in the bearish market trend non-financial factors like

banks core team, policies of government, GDP growth rate, base interest rate, customer

base, relation of bank with government officials was counted vital whereas in the bullish

market investors looked in company fundamentals mainly profitability and liquidity for

calculating intrinsic value of stock. This study also showed that age factor of investor

hugely determined their risk taking propensity and which factors they considered to be risk.

Young investors like to look company factors as shown by balance sheet in more detail

while investors above 30 years gave industry factors like level of competition, government

regulations that could hamper bank performance more importance. Moreover, elder investor

i.e. 30 above ones took hold shares for more than two years which was uncommon among

investors below 20 years. Selfresearch was the most applied tool to analyze the

fundamental factors.

Ariff (2000) investigated the key fundamental determinants of stock prices in Pakistan with

focus on understanding relationship between investors demographic characteristics and

fundamental factors included in their analysis. He also investigated the long-run relationship

between company fundamentals and response of investors that led to stock price behavior.

However, the lacunae that needs to be addressed and is being addressed here is the long-run

relationship between economy fundamentals and stock price behavior.


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Kevin (2001) pointed out the key economy, industry and company fundamental factors for

banks and financial institutions. According to his study the economy fundamentals include

Gross Domestic Product, inflation rate, exchange rate, interest rate and government

spending in infrastructure, industry fundamentals include demand and supply of money, the

emergence of domestic and multinational rivals substitute services, liquidity position and

changes in government policy and company fundamentals include the years of operation, the

quality of management, brand image of bank and financial institutions, financial ratios,

labor/management relation and dividend stability

Davari (2011) had conducted a survey that explored on affecting factors on fundamental

analysis by investors in Isfahan Regional Exchange with focus on listed banks and

concluded that macroeconomic factors have less impact on investors decisions and among

company related factors, competitive status, profitability analysis and financial analysis

impact on investors decisions. Bullish and bearish stock price of bank determines which

macroeconomic and company factors to consider for calculating the risk and return. It was

found that during bullish trend investors gave more importance to company factors

(especially profitability) and in the bearish trend it was the competitiveness among banks

and policy of central bank that mattered most.

Venkatesh, Tyagi and Ganesh (2012) conducted a study on Fundamental analysis and its

usage in Indian capital markets: A survey which investigated fundamental factors investors

use to make fundamental analysis in investing in financial institutions located in major

cities. The researchers used questionnaire survey. The findings of the research reveal that

more than 85 percent of the respondents rely upon both Fundamental to analyze on which

stock to invest in. This was true to investing in stocks of bank where investors highly

preferred company factors (profitability, earning per share, dividend payout and

management team) in bullish market trend whereas economic and industry factors were

highly studied for understanding its effects in bearish market. The survey envisages at

providing insights about the way traders operate in the market by using the fundamental

analysis information. The survey covered Brokers, Sub-Brokers, Fund managers, Portfolio

managers and others. The study puts an effort in trying to understand economic, industry

and company variables as a whole. The structured questionnaire comprehensively includes

all these components so as to arrive at that factor which is driving the market. The study


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records top ten Economy and Company factors as considered important by the respondents.

Indicators considered for investing, company financial and non-financial factors and various

Economic factors considered for judging the growth of the economy were included in the

questionnaire. Data sources and Methodology employed by the study consisted of a close-

ended questionnaire for the analysis. The closed ended questionnaire was admitted to a

sample of 600 respondents. Since the respondents chosen are from experienced seniors, the

analysis made was more accurate. The questionnaire was statistically validated using various

statistical tools such as, Mean, Standard deviation. One way ANOVA test was conducted

and was tested at 1%, 5% and more than 5% significance levels. The bottom line of the

survey concluded that, Economy and Company factors are most widely used fundamental

analysis components for forming forecasting views. 98% of the respondents have envisaged

the fact that company factors are important than the economy or the industry. With this it

was concluded that among EIC factors Company specific financial and non-financial

information acts as a major influencing factor while deciding upon which stocks to invest

in.The study concluded that (1) investors are largely comprised with those with long

investment horizon and importance of factors differed with their investment horizon. (2) For

bank share analysis, investors gave highest importance to liquidity position of the industry

and profitability of the bank for predicting stock return. (3) Industry factors were more

important in bearish trend and company factor in bullish trend.

Hossein, Nasser and Mohammadbagher (2012) studied the affecting factors on share

analysts decisions regarding their share analysis in the Tehran Stock Exchange (TSE). This

study attempted by in order to depict the affecting factors on analysts decisions in the

format of fundamental analysis. This analysis was studied in three sectors: (1)

economy/market, (2) industry, (3) firm. It employed analytical approach to study affecting

factors on analysts decisions. Its statistical population contains analysts in brokering

companies at Tehran Stock Exchange. The tool to collect data was questionnaire and SPSSsoftware was used to analyze data. This study focused on two major research questions:

(a)which factors namely economy/market, industry and firm have the highest importance in

analysts fundamental approach? (b) Among above three factors, which one has the highest

importance? Sampling and Sample Volume used by their study used sample means those

analysts who work in capital market to advise and analyze the market. They used simple


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random sampling method for a limited population. It showed that investors in the Tehran

stock exchange look for overall performance of the two or three big players in the banking

industry. Company factors were found to be more important than industry factors since few

banks could manipulate the overall performance of the industry. Based on the results, for

fundamental analysis, share traders considered mostly the management team, BOD, cost of

fund, dividend payout, profit margin, P/E ratio and directives of central bank affecting the

performance of these major banks. The output of the statistical test showed that investors

with different age considered firm specific factors differently. Young investors gave highest

importance to profitability whereas middle age and senior investors gave highest importance

to capital adequacy and goodwill of bank.

Allahawiah and Sameer (2012) assessed the factors affecting Stock Market Prices in

Amman Stock Exchange. This survey study had used empirical data from primary sources,

mainly by conducting a survey among a sample of portfolio managers, financial, brokers,

and top managers. They found that dividend policy and past record of dividend pay as key a

key factor that investors considered as an affecting factor on stock market price for investors

with long target on stock market. The empirical findings also showed how internal

management of the bank had major impact on its performance in the stock exchange. The

quality of management team showed that it had positive relationship to the stock market

price. The financial position with focus to liquidity position had positive relationship with

stock market price of banks. Portfolio managers were found to be giving top most priority to

the liquidity positions. This finding represented a step forward in understanding stock

market price behavior and how investors determine which fundamental factor is important

for them. The statistical tests showed that there existed significant relationship between

demographic characteristics of respondents and their choice of fundamental factors. Brokers

given their level of knowledge gave highest priority to profitability whereas portfolio

managers gave more importance to position of particular bank in the industry and loanportfolio, deposit collection and overall management team. Thus the basic findings from the

research from the ANOVA analysis indicate that education level and years of experience

had significant influence on rating given to various firm specific fundamental factors.

Professional investors choice of factors for fundamental analysis changed with their

investment horizon and market conditions affecting performance of bank.


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Shrestha (2010) studied the level of knowledge of Nepalese share traders regarding

fundamental analysis of factors related to banking industry. The researcher has tried to

highlight on education level of investors regarding investment in shares of commercial

banks. The study showed that in recent times investors have become more aware, they

evaluate all the major factors before making investment in share market.

It had collected data through primary collection and secondary collection with prime focus

on survey questionnaire which included both open ended and closed ended questions. A

statistical tool like chi-square was used. Moreover, from the study it was found that there

exists significant relationship between occupation of the investors and the type of

fundamental factors they consider for calculating stock return. However, it was found that

the person who makes frequent investment in shares doesnt depend upon his/her

qualifications; how frequent does an investor makes investment, how aware is the investor

about the share market and how much satisfied he/she is dependent upon the age group in

which investors falls and level of awareness about share market. In Nepalese context

investors showed no significant difference in the way they considered factor to be important

for bullish and bearish trend market. She concludes that investors are much knowledgeable

about the company factors of banks and on two or more source for analyzing the shares of

banks.

Pradhan (2011) had conducted a research study on Fundamentals and stock return in stock

market of Nepal for the partial fulfillment of Masters of Business Administration in the

year 2011 under Ace Institute of Management, Pokhara University. The study analyzed the

relationship between stock returns with firm specific fundamental variables, such as

earnings yield, cash flow yield, market capitalization of equity, book-to-market equity ratio,

equity beta, book and market leverage in Nepalese context. The method of data analysis

included correlation analysis, analysis by forming portfolios and cross sectional regression

analysis. Also, dealt with different statistical tests of significance for validation of modelsuch as t-test and F-test. For analysis of primary data it employed percentage frequency

distribution, cross tabulation, mean ranking scores of responses to likert scale items and non-

parametric test of statistical significance. An attempt was made to describe the character of

common stock returns of 14 commercial banks with a total of 47 observations during fiscal

year 2004/05 through 2009/05 through 2009/10 by using descriptive statistics with respect to


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firm specific fundamental variables. The study used both secondary and primary data.

Survey questionnaire was use to collect data with emphasis on what specific firm related

factors that investors considered while calculating intrinsic value of stock. The findings of

the study showed that investors opt for number of different fundamental variables while

making investment in stock of firms. It showed that attributes like experience, education

level and age factors have crucial role to play when it comes to selection of factors for

analysis before buying shares of a company. These attributes affect choice of firm specific

fundamental variables differently. Mostly experienced investors give special priority to

financial statements and midterm reports and among financial statement elements, real EPS

has the highest importance whereas less experienced and/or educated investors are fond of

stock price trend and find fundamental factors less useful while making fundamental

analysis of stocks.

Kadariya (2012) had conducted a study on Factors affecting investor decision making: A

case of Nepalese capital market as a full length research paper for M. Phil in the year 2012

under Tribhuvan University. The study attempted to analyze the market reactions to tangible

information and intangible information in Nepalese stock market, the descriptive and

correlational research design had been employed and the primary data used for the analysis.

Method of analysis employed by the study intended to analyze the market reactions of

tangible and intangible information and to analyze the investors behavior in capital market.

The factor analysis had been employed for the data analysis along with descriptive statistics

and correlation analysis. The analysis of first hand data information provides some findings.

The primary analysis includes the demographic features of the respondents, their perception

towards the cap

Fundamental factors of Commercial banks

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