Predictability of Stock Return using Financial Ratios: Evidence from CSE FMCG sector

Abstract

Purpose – This study aims to check the suitability of using financial ratios to predict the stock returns of FMCG sector in the Colombo Stock Exchange, Sri Lanka. Design/Methodology/Approach – The study uses four financial ratios from multiple areas naming profitability, liquidity, solvency, and market valuation with a sample of 30 listed FMCG companies for a period of six years from 2014 to 2019. The data were analyzed using multiple regression model to understand the predictability of the stock return. Findings – The results indicate profitability, liquidity and market valuation ratios can predict the stock return in the short term and the long term. The return on assets, current ratio and price earnings ratio had significant predictability on stock returns, while debt to equity ratio did not show any significant results owing to the companies being in the mature stage of their product lifecycle. Conclusion –Investors can adopt a financial ratio model including profitability, liquidity and market-based ratios as a primary model to predict their stock returns before moving on to sophisticated fundamental analysis models.