The research into stock price behavior and asset pricing continues, and a number of interesting results have surfaced recently. Perez-Quiros and Timmermann (2000) provide evidence that small firms have high average returns because they are more affected by tight credit market conditions. Small firms do not have the same access to domestic and international bond markets that are enjoyed by large firms. Since the availability of credit is tied to economic conditions, so that a credit contraction typically occurs near a recession, small firms would be very sensitive to systematic variation in credit market conditions. Thus, the high returns to small firms might be compensation for the high sensitivity to a credit-related risk factor.
A study by Elton, Gruber, Agrawal and Mann (2001) reports a potentially important link between the equity and fixed income markets. If certain risk factors are pervasive enough to explain common variation in stock returns, it is reasonable to expect that these same risk factors would be at work in the bond market as well. Elton, et al provide evidence that SMB and HML do just that. Their research isolates the portion of a bond's return that is due to changing risk premiums, and they show that this part of the bond's return is strongly related to SMB and HML. Not only does this result support the risk-based story, but it also suggests some interesting avenues for future research in fixed income portfolio management.
The issue of whether the value and size premiums are caused by risk or inefficiency may never be resolved to everyone's satisfaction. Feelings run strong on both sides of the argument. For investors, there are two crucial points to remember. First, factors based on value and size has explained much of the common variation in US stock returns for the past three-quarters of a century. Second, value and size premiums have been observed in several other countries, with the value premium being observed in nearly every country that has been studied.
While these observations are consistent with a risk-based story, they do not prove anything. Nevertheless, something very fundamental would have to change in the financial markets in order for these premiums to disappear. Furthermore, the returns observed in the US market during 1999 show that "value-minus-growth" is not a low-risk strategy.
1.2 Background
Otavio Ribeiro de Medeiros, Paulo Roberto Barbosa Lustosa, Jose Alves Dantas, (2004), investigated that the empirical tests are applied to firms listed in the Sao Paulo Stock Exchange (Bovespa) belonging to the oil & gas, basic materials, industrial goods, construction, transportation, and cyclical and non-cyclical consumption goods industries, with data extending from the 2nd quarter of 2001 to the 3rd quarter of 2004. Our main result relates to finding empirical support for the hypothesized positive association between operating leverage and stock returns.
The null hypothesis that non expected degree of operating leverage does not contribute to explain stock returns is amply rejected. The statistical results indicate that operating leverage, besides incorporating an earnings dimension, is one of the factors determining the systematic risk of stocks and that there is a relationship between risk and stock returns, so that it is possible to infer an association between the degree of operating leverage and stock returns. Our sample includes data extending from 2001 to 2004 of firms Listed on the Brazilian Stock Market, Otavio Ribeiro de Medeiros, Paulo Roberto Barbosa Lustosa, Jose Alves Dantas, (2004).
1.3 Statement of the Problem
The research aim is to analyze the impact of operating leverage on the stock returns of that listed firms. The research aim is to find out relationship between operating leverage and stock return. Moreover, this research is for finding the impact of low and high operating leverage on profitability and stock return of the listed companies in Karachi stock exchange.
1.4 Research Question
1.4.1 Primary Question
Does operating leverage impact on stock return?
1.4.2 Secondary Questions
1. What is the impact of low operating leverage on stock return?
2. What is the impact of high operating leverage on stock return?
1.5 Purpose of the Study
This applied research will provide better understanding to stakeholders of the operating leverage, benefits and limitations and clear image of the relationship between operating leverage and the stock return of that firm.
For the firms, it is very necessary to reduce the financial risks. This research will also give the impact analysis of the operating leverage and the stock return of the firm. The study aims at, providing sound understandings of operating leverage and its impact on stock return. The comparative analysis between the operating leverage and stock return will provide the understanding of the importance of operating leverage using by listed firms and impact on stock return of the firm. The purpose of this research is to develop findings of practical relevance to organizational stakeholders as well.
1.6 Scope
The scope of this study is all listed firms of Pakistan. It will consist of listed companies especially with concept and practice of operating leverage. Listed companies of Karachi stock exchange will be sampled and generalization will be made for the population, which consists of all listed companies in Pakistan. Moreover, the data of these firms will be analyzed through comparison of relationship between the operating leverage and stock return. It means all listed companies in stock exchange are included in the scope of the study.
1.6 Delimitation
It will only consist of listed firms of Karachi stock exchange especially with concept and practicing of operating leverage; no other fields will be considered. This research will only see the impact of operating leverage on the stock return of the firm. That’s why; this will not include the all operations of the firm. It will only consist of those departments of the firms, which are directly involved with the operating leverage and stock return measurement, like the treasury and finance departments.
1.7 Basic Assumption
The basic assumptions taken for the research are:
There is one independent variable i.e. the operating leverage process adopted by the listed firms and the dependent variables are the stock return of the firm.
This research assumes that no political impact or regulation will affect the listed firms. The legal issues’ pertaining to operating leverage in consumer banking is not the subject matter, and hence will not be discussed. If any changes take place in these aspects, this research may not be applicable.
1.8 Justification
This thesis is aimed at providing better conceptualization of operating leverage for the firm specific to listing in Karachi stock exchange. This research will give clear image of the relationship between the practice of the Operating leverage and Stock return of the firm. The target audiences are the consumers of the operating leverage and stakeholders of the operating leverage. Those consumers and stakeholders can easily understand the usefulness, importance and relationship between the operating leverage and the stock return of the firm.
1.9 Hypothesis
Hypothesis NO 1:
Ho: Operating leverage does not impact on stock return of the listed firm.
H1: Operating leverage impacts on stock return of the listed firm.
Hypothesis NO 2:
Ho: High operating leverage does not impact on low stock return of the listed firm.
H1: High operating leverage impacts on low stock return of the listed firm.
Hypothesis NO 3:
Ho: Low operating leverage does a not impact on high stock return of the listed firm.
H1: Low operating leverage impacts on high stock return of the listed firm.
