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IMPACTS OF RATIO ANALYSIS ON INVESTMENT
DECISION IN THE BANKING SECTOR OF NIGERIA
ABSTRACT
The study
examined impact of ratio analysis on investment decision in banking sector in
Nigeria, a case study of three selected commercial banks in Lagos State. A
well-constructed questionnaire, which was adjudged valid and reliable, was used
for collection of data from the respondents. The data obtained through the
administration of the questionnaires was analyzed using the Pearson correlation
analysis.
The results
showed that there is positive and significant relationship between ratio
analysis and investment decision in the selected commercial banks in Nigeria
(r=0.772; p<0.05). The results were found to be consistent with empirical
findings of past studies in literature.
The study
concludes that that there is significant relationship between Total Ratio
Analysis variables and Number of Shares Traded (NOST) in the banking sector of
Nigeria. This is in line with ratio analysis being significant with investment
decision.
Based on the
findings of the study, the study recommends that; Ratio analysis, should be
employed by the financial management of every bank, to ensure that bank’s
assets are safeguarded, cash inclusive; Finance, accounting department should
be established in every bank, which should be headed by a qualified accountant;
The bank management should be used to a particular ratio which has been more
beneficial to them; The bank management should be observant when it comes to
investing, they should always be certain of the return, and timing period is
very necessary.
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
In every
organization, regardless of its size and structure, ratio analysis plays a
crucial role in decision making. Ratio analysis is a tool used to analyze the
financial performance and position of a company and it means different things
to different people i.e. it is computed by different users for different
reasons (Usman Mohammed, 2004). Amina
Haji Nkuhl (2015) defined ratio analysis as the judgmental process which aims
at evaluating the current and past financial positions and results of an entity
the primary objectives of determining the possible best estimate. Investment
decision was defined by Omolumo (2000) as the means of allocating fund to
invest proposals whose benefits are to be realized in the future. The
fundamental statements or accounts to be analyzed by stakeholders who intend to
compute ratios are the statement of comprehensive income, statement of
financial position, statement of cash flows and statement of changes in
financial position (Amina Haji Nkuhl, 2015)
Amina Haji
Nkuhl (2015) also suggested that investors use information from financial
statements to test if the company they are about to invest in will be able to
meet up with its objective as the primary objective of every firm is to
increase its shareholders wealth either through the payment of dividends or
through the increase in the market value of the company’s shares. The financial
statement is usually expressed in monetary terms and analyzed by a financial
manager employed in the case of a company or even an individual who wants to
invest in a company (Amina Haji Nkuhl, 2015). The analysis of financial ratios
computed by the financial manager shows the operating and financial efficiency
and growth of a firm and also determines the ability of the firm to meet its
obligations, the extent to which the firm has used its long term solvency from
borrowed funds and the overall operating efficiency and performance of the
firm. The job of a financial manager is therefore, very important as his
responsibilities involves identifying and appraising the viability of available
investment using various techniques, deciding on the appropriate way to finance
the chosen investment and also determining how much to be paid as dividend to
the company’s shareholders (Usman Mohammed, 2005).
As a result
of economic hardship and inflation in the economy, it becomes very important to
adopt a very effective and reliable means of evaluating the performance of
companies for investment decisions by investors, management, shareholders,
creditors and even the general public (Dr. Adeghe, R. & Atu, O. K,
2015). Financial ratio analysis is
important to analysts, therefore, ratios are intended to provide meaningful
relationship between individual values in the financial statement (Reilly,
Brown, 2006). It makes sense to provide a vast number of potential ratios
because a single number from the financial statement is of little value unless
it is compared to ratios of other entities. A firm’s performance can be
relatively compared by an aggregate economy, by its industries or by its past
performance (Reilly, Brown, 2006). As with all ratios, a comparison with other
firms in similar industries is useful, and a comparison of these ratios for the
same firm from period to period is important in pinpointing trends and changes.
It is also important to keep in mind that these ratios are interrelated and
should be examined together rather than independently.
Studies have
shown that ratio analysis could influence investment decision making. Usman
Mohammed (2005) expressed that financial ratios are calculated from financial
statements prepared by an accountants which, to an extent influenced investment
decisions of common stock holders either to maintain their stock in the
company, reduce their stock or disinvest in the company. Usman Mohammed (2005)
also stated that of all the tools of financial analysis, ratio analysis is the
most widely used because the level of the historical trends of ratio analysis
can be used to make inferences about a company’s financial condition, its operations
and attractiveness as an investment. Helfert (1997) (as cited in Andabai, P. W
& Egoro, S. A, 2017) argued that, comparing the ratios for several
successive years and observing for especially favorable ends, ratio analysis
might provide the important early warning signals that allows for the solving
of business problems before it becomes too late. Finally, it must be emphasized
that ratios must be compared with some prevailing standards because it cannot
in itself, convey any meaningful and useful result.
1.2 Statement of the Problem
As the main
objective of every organization is to maximize their shareholders wealth
through the payment of dividend and the increase in the market price or value
of their shares (Amina, Haji Nkuhl, 2015). Investors also have a part to play
in ensuring that this objective is achievable through the decisions they make
regarding the companies they invest their resources (Abdulrasq Abdullahi,
2009). Investors are provided with the financial statements to evaluate performance
before making these decisions but, the performance of a company cannot be
measured through mere looking at the financial statement, analysis like ratios
have to be computed in order to properly understand the financial statement and
make good decisions that will benefit the investor and increase shareholders
wealth.
Many
potential investors, shareholders and other users of the financial statement
are unable to analyze the financial statement of companies because of their
lack of knowledge and understanding in financial statement analysis. Some of
them employ a financial analyst to help them out but sometimes it is not always
certain if the necessary disclosures made in the financial statement is
misleading or not (Amina, Haji Nkuhl, 2015). According to Onyekwelu (2010) as
cited in Anaja, B. and Onoja, E. E. (2015), one of the most difficulties facing
the auditing profession is that no auditing process can provide absolute
assurance in the detecting of all fraudulent financial reporting. According to Duru
(2012), this led to a believe that the annual financial statements of have
failed in its responsibility to provide the credible information needed for
investors and other uses of financial statements.
After making
initial and conscious investment decisions, majority of the existing
shareholders tend to use cash dividend and interest paid to evaluate the
performance of companies for investment decisions instead of computing ratios
(Dr. Adeghe, R. & Atu, O. K. 2015). Cash dividend and interest paid are just
mere figures in financial statements which cannot be used to evaluate the
worthwhileness of investing in a company. Ratio analysis has been stated to be
one of the most powerful tools used for financial analysis but the difficulty
of choosing the right ratios to be computed when analyzing the financial
statement becomes a burden for investors and other users of the financial
statements (Usman Mohammed, 2005).
These stated
problems tend to threaten both the existing and potential investor while making
investment decisions. And as a result of these problems, the research will
examine the impact of ratio analysis on investment decision making.
1.3 Objectives of the study
The primary
objective of this research work is to evaluate the impacts ratio analysis on
investment decisions in the banking industry of Nigeria.
Specifically,
the objective of this study are to examine the impacts of:
Price earnings on the number of shares
traded in the banking sector of Nigeria.
Dividend Yield Ratio on the number of
shares traded in the banking sector of Nigeria.
Debt to Equity Ratio on the number of
shares traded in the banking sector of Nigeria.
Return on Shareholders’ Equity on the
number of shares traded in the banking sector of Nigeria.
Net Profit Margin on the number of shares
traded in the banking sector of Nigeria.
1.4 Research questions
The
following research questions will guide the study
To what extent would Price Earnings Ratio
influence the number of shares traded in the banking sector of Nigeria.
To what extent would Dividend Yield Ratio
the number of shares traded in the banking sector of Nigeria.
To what extent would Debt to Equity influence
the number of shares traded in the banking sector of Nigeria.
To what extent would Return on
Shareholders’ Equity influence the number of shares traded in the banking
sector of Nigeria.
To what extent would Net Profit Margin
influence the number of shares traded in the banking sector of Nigeria.
1.5 Research hypotheses
In an
attempt to answer the research questions the following hypotheses have been
developed. The hypotheses are stated in alternative and null forms as follows:
H1: There is
a significant relationship between Total Ratio Analysis variables and Number of
Shares Traded (NOST) in the banking sector of Nigeria.
H0: There is
no significant relationship between Total Ratio Analysis variables and Number
of Shares Traded (NOST) in the banking sector of Nigeria.
1.6 Scope of the study
The scope of
this research will be restricted to three banks which are United Bank of
Africa, Zenith Bank and Diamond Bank plc.
.
1.7 Significance of the study
This study
will be of immense benefit to potential investors, shareholders, creditors,
bond holders and other stakeholders like the government, employees, students,
lecturers, stockbrokers, managers etc. as it would help them in decision
making. The findings of this study will help in guiding the future actions of
various stakeholders of a company.
The finding
of this study will help potential investors who want to invest to see the
potential probability, long term stability, dividend policy and potential growth
of the of the company in order to make effective investment decisions. The
study will also reveal the extent to which shareholders are influenced by
financial ratios when making investment decisions.
The findings
of this study will also help creditors make effective decisions by checking
the liquidity of the organization which
means the ability of the organization to settle its debts and obligations by
paying for goods and services as at when due, paying interest and repaying the
principal sum on loans obtained.
The
government will benefit from the findings of this research because they rely on
ratio analysis like the liquidity and profitability ratios to determine and
assess companies for tax purposes. The interest of the employee is how well
their welfare can be improved which is determined by the long term stability
and survival because their jobs depends greatly on it.
So as to
provide a more comprehensive view of the financial position and performance of
the organization, financial analysis is performed with the information obtained
from the financial statements. The managers are primarily concerned with the
profitability, efficiency, performance evaluation, internal control and
management of assets of the business.
1.8 Limitations of the study
Research
studies on ratio analysis is usually based on a large number of firms but due
to time constraint, this study will be based on only two selected banks in
Nigeria for a period of seven years (2010-2016). This study will be limited to
the use of quoted companies because most small or medium scale enterprises in
Nigeria do not publish their financial statements and are unwilling to release
them which is constraint to the availability of data.
1.9 Operationalization of variables
Operationalization
of variable is defined as the creation of a model for research variables. The
relationship and model employed for this study is given as follows
Y=f(X)
y= Dependent
Variable
Y=NOST
X=
independent Variable
x1= PER
x2= DYR
x3= DER
x4= ROSE
x5= NPM
To capture
investment decisions, the number of share traded was employed, while to capture
ratio analysis, Price Earnings Ratio, Dividend Yield Ratio, Debt to Equity
Ratio, Return on Shareholder’s Equity and Net Profit Margin was employed.
NOST = f (PER, DYR, DER, ROSE, NPM)
Where
NOST =
Number of Shares Traded
PER = Price
Earnings Ratio
DYR =
Dividend Yield Ratio
DER = Debt
to Equity Ratio
ROSE =
Return on Shareholder’s Equity
NPM = Net
Profit Margin
1.10 Definition of key terms
Ratio:
Mathematically, Ratio refers to the relationship that exists between two or
more variables. According to Pandey (2005), ratio is “the indicated quotient of
two mathematical expression” and as “the relationship between two or more
things”.
Ratio
Analysis: Amina Haji Nkuhl (2015) defined ratio analysis as the judgmental
process which aims at evaluating the current and past financial positions and
results of an entity the primary objectives of determining the possible best
estimate
Financial
analysis: this is the selection,
evaluation and interpretation of financial data contained in the financial
statement along with pertinent information, to assist in investment and
financial decision making. (Pamela Peterson Drake, 2005)
Financial
Statement: A financial statement is a detailed report that shows the management
performance, financial performance, position and cash flows of a business for a
specific period. (Prince Casmir Idekwulim, 2014)
Statement of
Financial Position: This can be defined as a statement that shows the financial
wealth of a business. Basically, it shows the summary of an entity’s assets,
liabilities and equity for a given period. (Prince Casmir Idekwulim, 2014)
Statement of
Profit or Loss and other Comprehensive Income: This reports a company’s
financial performance over a period of time. It shows the profit earned or loss
incurred and income and expenses that occurred during a period. (Prince Casmir
Idekwulim, 2014)
Statement of
Cash flows: This statement shows how changes in statement of financial
performance and position affect cash and cash equivalents and breaks the
analysis down to operating, investing and financing activities. (Prince Casmir
Idekwulim, 2014)
Investment
Decision: investment decision can be defined as a firms decision to invest in
its current funds efficiently in long-term assets whose benefits are
anticipated to be realized in the future. (Amina Haji Nkuhi, 2015)
Investors:
Investors are people who commits capital in order to gain financial returns.
Price
Earnings Ratio: This ratio evaluates if stock is over or under priced. It
reveals how many times the capital value of a business is higher than its
current level of earnings and measures the level of confidence the market have
in the future of the business.
PER = Market
price per share
Earnings per share
Dividend
Yield Ratio: This ratio measures the percentage of the return through dividends
when compared to the price paid for the stock or the cash returns from share to
its market value.
DYR=
Dividend per share
Market price per share
Debt to
Equity Ratio: This ratio measures the financial risk exposure level of a
business. It also measures the amount of a company’s capital is financed by
debt.
DER = Total
liabilities
Total shareholders fund
Return on
Shareholders’ Equity: This ratio measures the percentage of returns on ordinary
shareholders’ investment based on a period’s performance.
ROSE = Net
profit
Total Shareholders’ Equity
Net Profit
Margin: This ratio measures the proportion of the sales revenue that is earned
as profit after deducting all expenses excluding interest and tax.
NPM = Net
profit x 100%
Revenue
Number of
Shareholders: This refers to the amount of people that legally owns one more
shares in a company for a period.
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