Do Company Fundamentals Explain Stock Market Performance?
In this article, I will be doing statistical analysis on NYSE firms to see if we can find any patterns between company fundamentals and their share prices.
I will use a data set from Kaggle, which provides information on share prices, business fundamentals, and sector classifications.
I thought a good starting point for this article would be to see if we can use fundamentals data to describe why certain market sectors outperform others. As we can see from the table below, there is a sharp distinction between the best-performing sector (healthcare) and the worst-performing sector (energy). If stock fundamentals were to play role in sector performance it should be easy to see a relationship.
Here is a correlation heat map of 446 companies between various sectors. Correlation maps make it easy to see if there are statistical relationships between multiple variables. Positive correlations are colored in green-blue and negative correlations are colored in red. Ideally what we would look for here are strong correlations (values larger than .8) that will have stronger predictive power. Specifically, we want to look at the open price or cumulative returns tickers since that is what we are trying to predict.
Unfortunately, and not surprisingly, most of our correlations relating to price are fairly weak. But I still think we can find some interesting insights using weaker correlations.
We can see that EPS (earnings-per-share), capital expenditure and cash ratio (ratio between cash and liabilities) all have positive correlations with opening prices. With EPS being the only significant positive correlation.
Then everything else seems negatively correlated with opening price. Oddly enough, even increases in income and revenue are negatively correlated with stock price. Almost doesn’t make sense intuitively, but okay.
From this data though, I will make a few predictions. That stocks with higher EPS will perform better than stocks with lower EPS. That high-performing sectors (Healthcare, I.T., Financials) will have higher EPS than low-performing sectors (Energy, Real Estate, and Telecommunications).
I will also predict, that companies with more shares outstanding (number of company shares sold to the public) will perform worse than companies with fewer shares outstanding.
Let’s do some more data exploration to see if my predictions are correct.
Here I am looking to see if there is a clear pattern that EPS leads to higher sector returns. However, upon quick inspection there doesn’t really seem to be a relationship between the magnitude of the blue EPS bar and the magnitude of the green returns bar. Without going into a lot of detail I think we can dismiss that EPS plays a large role in sector performance.
Perhaps, though, if we look at individual stock we will see a more clear relationship. Let’s look at some charts of the highest/lowest EPS companies.
Okay, upon first glance it would seem like the higher EPS companies have some better performing companies, but it’s hard to get a clear picture of what is going on so I’m going to clean things up a bit.
After combining the performance histories of each company we can distinctly see that high EPS companies, on average, outperform companies with lower EPS.
Now let’s test my other prediction. That higher estimated shares outstanding (ESO) will lead to lower stock returns on average.
Let’s make another messy graph:
Again, difficult to make out what is happening but I still think it is good to visually inspect what is happening in case we can see any additional patterns.
Now the cumulative returns graph:
After combining the performances of the two charts we can see that lower ESO companies do, in fact, outperform higher ESO companies.
My best guess to why this is the case is simply that companies that are doing very well off financially are capable of issuing out stock buybacks which, in term, lowers the total number of shares outstanding in the stock market.
Additionally, stocks that are in financial trouble might issue out more shares to raise emergency capital which then increases the total shares outstanding on the market.
Conclusion:
It does seem that, on average, we are able to predict whether a cluster of companies will outperform or under perform the stock market based on fundamental data of individual companies.
However, fundamental data seems insufficient at explaining the performance of individual stock market sectors.
In The Future:
I’d like to explore whether I can combine several positive/negative correlating indicators to predict market returns with a higher degree of accuracy.
Maybe create some sector specific heat maps to see if there are different correlations between different sectors.
Also, I’d like to do an analysis on why income/profits is showing a negative correlation with stock pricing because that seems completely backwards and nonsensical.
