ABSTRACT

Martikainen, Teppo (1990). The individual and incremental significance of the economic determinants of stock retums and systematic risk. Acta Wasaensia No 24, 192 p.

The main interest of this paper is to find out whether there exist different financial characteristics of a firm which are individually and incrementally significant economic determinants of stock returns and systematic risk. The background to the study is the finding that although the connection between profitability and stock prices has been the object of a great number of studies, little is known how the other financial characteristics are reflected in stock prices.

Based on previous theoretical and empirical work two research hypotheses are stated. Firstly, different a priori financial characteristics of a firm that are theoretically as well as empirically individually significant economic determinants of stock returns and systematic risk are expected to exist. Secondly, a remarkable part of this importance is expected to disappear when studying the incremental significance of these economic determinants.

The empirical results support the research hypotheses stated. Four financial characteristics (profitability, financial leverage, operating leverage and corporate growth) of a firm seem to tie individually important determinants of stock returns and systematic risk. On the other hand, a remarkable part of this importance is removed when the incremental importance of these characteristics is studied. Typically, the relevant information can be presented in one factor which respect to single financial ratios seem not have incremental information content. In cross-industry sample this factor is reported to be leverage. However, when studying purely industrial firms, the most important factor consists of ratios representing several a priori characteristics of a firm.

Teppo Martikainen, School of Business Studies, University of Vaasa, Raastuvankatu 31, -65100 Vaasa, Finland.

KEYWORDS Financial ratio analysis, classification of financial ratios, Capital Asset Pricing Model, stock retums, systematic risk.