Role of market return in determining stock returns
Understanding the complex relationship between stock and market returns is vital in the dynamic realm of finance. Returns serve as barometers for investment profitability, facilitating performance evaluation and risk assessment for investors pursuing their financial objectives. Stock return measures the price percentage change of an individual stock, reflecting its performance and profitability. Conversely, market return signifies the collective performance of a broad stock market index. Analyzing both is critical since it enables investors to compare individual investment performance with broader market trends, aiding informed decision-making and risk management. There may still be aspects of market return and stock return relationship that are not fully understood or explored in existing research. This article underscores the significance of each in shaping investment strategies. It empowers investors with valuable insights into portfolio management, risk evaluation, and optimizing returns in volatile markets.
Relationship between stock and market return
The relationship between market return and stock return is essential because it helps investors assess a stock’s sensitivity to broader market movements. A positive correlation suggests the stock tends to move in sync with the market, while a negative correlation implies an inverse relationship. By examining this linkage, investors can gauge how a stock might perform under different market conditions, aiding portfolio diversification, risk management, and investment decision-making. Hence, studying the relationship between market and stock returns is critical for optimizing investment strategies and managing risk effectively (Merkoulova & Veld, 2022).
Methodology
To fulfil the study objective, daily data for the year 2017-2018 is collected for the analysis. The data combines different companies’ open and close prices of stocks and their market open and close values. The tool that will be used is STATA. Two methods are used for analysis, i.e., regression and trend. Regression analysis helps to understand the magnitude of impact while trend analysis helps to assess the linkage between the two over the selected period
The most suitable method is regression analysis as regression models help quantify how changes in market returns affect individual stock returns. It can identify factors that explain variations in stock returns, including market movements.
Analysing the stock returns of the Energy sector
The energy sector encompasses the production, distribution, and consumption of various forms of energy, including fossil fuels, renewable sources, and electricity. It plays a vital role in powering modern economies and societies.
| Return | Coef. | Std. error | t | P>|t| |
|---|---|---|---|---|
| Market return | .006 | .0008 | 7.11 | 0.000 |
| _cons | -.350 | .164 | -2.13 | 0.034 |
The slope value of 0.006 implies that a 1% market return increase corresponds to a 0.006 stock return increase, indicating a positive relationship between market and stock performance. Conversely, the intercept value of -0.350 signifies the expected stock return when the market is unchanged, suggesting potential negative returns due to specific stock factors or unaccounted external market conditions.
NHPC
The daily stock return for NTPC, SE Power, Adani Power, Adani Transmission, BHEL, Gujarat Industries Power, GVK Power, Jaiprakash Power, JSW Energy, KEC International, Rattan Power, Reliance Power, Tata Power, and Torrent Power consistently remains at zero with no fluctuations. Market returns exhibit continuous fluctuations, typically ranging between -500 to 500. In quarters one and three, market returns stay within the -500 to 500 range, while in quarters two and four, they dip below -500. Additionally, in the last quarter, market returns surpass 500. Notably, there is no discernible correlation between the movements of market returns and stock returns for these companies, indicating a lack of association.
NTPC
The daily stock return data consistently hovers near zero, displaying minor fluctuations. This pattern signifies a lack of linkage with the market return.
Indian Energy Exchange
There is a slight variation in stock return alongside market return, suggesting the possibility of a link between the two.
Kirloskar Industries
The daily data for stock return goes a little ahead of zero, trying to meet market returns representing the possibility of linkage between variables.
Power Grid
The daily data for stock return stays near zero, with minor fluctuations.
Reliance infra
There is slight variation in stock return along with market return representing the possibility of a linkage between the two.
Thermax
The stock return for the company is moving in tandem with the market return, indicating the presence of a linkage between the two.
In conclusion, for all the companies in the energy sector, the stock return generally fails to align closely with the movements in market return. The highest peaks and lowest troughs are predominantly observed in the last quarter, while the second quarter tends to exhibit lower highs and lows.
Analysing the stock returns of the Pharma sector
The pharmaceutical sector is dedicated to the comprehensive process of researching, developing, manufacturing, and distributing drugs and medications. These products play a crucial role in enhancing public health and addressing a wide range of medical conditions. Due to the larger number of selected companies, they were divided into two groups for closer examination and analysis.
The analysis for the 1st group of the pharma sector is presented below.
| Return | Coef. | Std. error | t | P>|t| |
|---|---|---|---|---|
| Market return | 0.01 | 0.00 | 8.57 | 0.00 |
| _cons | -0.80 | 0.15 | -5.20 | 0.00 |
The slope value of 0.01 implies that a 1% market return increase corresponds to a 0.01 stock return increase, indicating a positive relationship between market and stock performance. Conversely, the intercept value of -0.80 signifies the expected stock return when the market is unchanged, suggesting potential negative returns due to specific stock factors or unaccounted external market conditions.
| Return | Coef. | Std. error | T | P>|t| |
|---|---|---|---|---|
| Market return | 0.00 | .001 | 3.42 | 0.00 |
| _cons | -1.92 | 0.39 | -4.91 | 0.00 |
The slope value of 0.0 indicates that a 1% increase in market return corresponds to no change in stock return. On the other hand, the intercept value of –1.92 implies the expected stock return when the market is unchanged. This suggests the possibility of negative returns attributed to specific stock factors or unaccounted external market conditions.
Gufic Biosciences
The daily stock return data consistently remains near zero with minimal fluctuations. In contrast, market returns exhibit continuous fluctuations, generally ranging between -500 to 500. In quarters one and three, market returns stay within the -500 to 500 range, while in quarters two and four, they dip below -500. Additionally, in the last quarter, market returns surpass 500. The absence of similarity in movement indicates no linkage between stock return and market return for the companies Gufic Biosciences, IOL Chemicals, Morphen Labs, Orchid Pharma, Alpha Labs, Ind-Swift Labs, Nectar Lifesciences, SeQuent Scientific, Bajaj Healthcare, Biofil Chemicals, Jagsonpal Pharma, Kilitch Drugs, Kopran, Lincoln Pharma, Mangalam Drugs, and Suven Life Sciences.
NGL Fine Chem: There is the existence of slight movement in return along with market return showing some possibility of linkage. 
Aarti Drugs: The daily data for stock returns have low-level fluctuations representing chances of linking with market returns. 
Hikal: Slight movement could be seen in return value for the company representing the possibility of linkage. 
Indoco Remedies: The daily data for stock return have minor fluctuations showing the existence of a linkage between variables. 
Natco Pharm: The daily data for stock return does not stay at zero but instead witness fluctuations similar to market return representing the possibility of connecting with market return. 
Shilpa medicare: The daily data has some fluctuation depicting the possibility of a link with market return. 
Syngene: The slight variations in daily return represent the existence of a link with the market return. 
Themis Medicare: The daily data for stock return has variations along with market return depicting the presence of linkage with market return. 
Wockhardt: The daily data for stock return have variations similar to market return but at a lower extent representing the possibility of a relationship between the two. 
Abbott India: Daily stock returns fluctuate between 0-500, mirroring market returns with continuous fluctuations between -500 to 500. The similarity in movement suggests a linkage between stock and market returns. 
Amrutanjan Health: The daily data for stock return has slight variation along with market return. 
AstraZeneca: The stock return has the existence of variation similar to market return representing the possibility of linakge. 
Biocon: A slight variation could be seen in stock return compared to market return representing the possibility of linkage. 
Dr Reddys: Daily stock returns hover near zero with continuous fluctuations, attempting to align with market returns. This suggests the potential for a linkage between stock return and market return. 
Ipca Labs: The daily data for stock return has slight variation representing the existence of a link with market return. 
Jubilant Pharma: The daily data for stock return has slight fluctuation which depicts the possibility of a link with market return. 
Laurus Labs: The presence of slight variation in return represents the possibility of a relationship between stock return and market return. 
Lupin: The stock return had slight variations along with the market return showing the possibility of linkage between the variables. 
Medicament: The stock return daily data has slight variation along with market return representing the possibility of the presence of a relationship between stock return and market return. 
Sanofi India: The daily data for stock returns have high-level fluctuations. It’s trying to match market returns. This represents the presence of a linkage with market return 
Unichem Labs: The daily data for stock return stays at zero and close, with low-level fluctuations showing the lower possibility of a link with market return.
Hence, in all the companies of pharma, for most companies, the stock return moves along with the market return. Also, the majority of highs and lows can be seen in the last quarter. The second quarter has low highs and lows.
Concluding Fiscal Year 2017-18 Analysis
In the fiscal year 2017-18, the analysis highlights consistent underperformance of stock returns in the pharmaceutical and energy sectors relative to the market. Market returns displayed fluctuations, with a dip in the second quarter, followed by moderate performance in the first and third quarters, and a substantial surge in the final quarter.
For the energy sector, few companies exhibited a link with market returns, while in the pharmaceutical sector, most companies showed a tendency to move along with market returns, indicating a higher likelihood of a connection.
References
- Merkoulova, Y. and Veld, C. (2021) ‘Stock return ignorance’, Journal of Financial Economics, 19(40). doi: 10.1016/j.jfineco.2021.06.016.
- Paul, V. R. and Somanathan, K. (2018) ‘Trend and Regression Analysis of Stock Market Price of Select Industries in India’, Scholars Journal of Economics, Business and Management (SJEBM), 5(1), pp. 17–23. doi: 10.21276/sjebm.2018.5.1.3.
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