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Impacts of Profitability and Growth on Stock Returns of the listed

Manufacturing Companies at Dhaka Stock Exchange in Bangladesh

Article  in  International Journal of Managerial and Financial Accounting · March 2023

DOI: 10.1504/IJMFA.2023.10051720

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372 Int. J. Managerial and Financial Accounting, Vol. 15, No. 3, 2023

Impacts of profitability and growth on stock returns

of the listed manufacturing companies at Dhaka stock
exchange in Bangladesh

Maisha Marium Rahim

Gisma Business School,
University of Law,
30169 Hannover, Germany
Email: tanhamaisha1@gmail.com

Md. Sharif Hassan

Faculty of Business and Communication,
Universiti Malaysia Perlis,
01000 Kangar, Perlis, Malaysia
and
Department of Business Administration,
University of Asia Pacific,
Dhaka 1212, Bangladesh
Email: mdsharifhassan27@gmail.com

Muhammad Mohiuddin*
Faculty of Business Administration,
Laval University,
Quebec, Canada
Email: mmohiuddin@tru.ca
*Corresponding author

Abstract: The study aimed to examine the impact of profitability and growth
on the adjusted stock return of the listed manufacturing companies at the Dhaka
stock exchange, Bangladesh. The study included 198 manufacturing companies
operating in 14 sectors. The combination of cross-sectional and time-series data
has constituted panel data. We hypothesise the positive and significant
relationship between profitability and growth, and stock returns, pooled OLS
multiple regression model, fixed effect regression model, and random effect
regression model has been developed. The findings showed that all the
independent variables except for the operating profit margin (OPM) positively
impact the stock return. The variables did not influence the investor’s stock
investment decision, except for the net profit growth (NPG) measure. The
positive connection between other profitability ratios and the stock return has
not turned out to be robust and significant mainly because of the speculative
and non-analytical investment decision-making by individual-level investors.

Keywords: gross profit margin; GPM; operating profit margin; OPM; net
profit margin; NPM; ROA; ROE; gross profit growth; GPG; net profit growth;
NPG; adjusted stock return; panel data analysis.

Copyright © 2023 Inderscience Enterprises Ltd.

 Impacts of profitability and growth on stock returns of the listed 373

Reference to this paper should be made as follows: Rahim, M.M.,

Hassan, M.S. and Mohiuddin, M. (2023) ‘Impacts of profitability and growth
on stock returns of the listed manufacturing companies at Dhaka stock
exchange in Bangladesh’, Int. J. Managerial and Financial Accounting,
Vol. 15, No. 3, pp.372–392.

Biographical notes: Maisha Marium Rahim completed her MSc in Corporate

Financial Management from GISMA Business School, University of Law,
Germany. Her research interest area includes corporate financial management,
financial statement analysis and accounting.

Md. Sharif Hassan is a PhD Scholar at Faculty of Business and Communication

of Universiti Malaysia Perlis. He is also a Lecturer at Department of Business
Administration of University of Asia Pacific, Bangladesh (currently on study
leave). He completed his BBA in Finance from East West University and MBA
in Accounting Information Systems from University of Dhaka. His research
interest areas include FinTech, financial statement analysis, behavioural
finance, information systems, and green finance.

Muhammad Mohiuddin is an Associate Professor of International Business in

the Faculty of Business Administration and Director at Research and Study
Group on Contemporary Asia (GERAC) of Université Laval. He received his
PhD in International Business from Université Laval, Canada. He is also the
Associate Editor of Transnational Corporations Review. His area of
specialisation includes international business and global strategy.

1 Introduction

In the Dhaka Stock Exchange of Bangladesh, 390 companies are listed to trade their
securities. Out of them, 237 are manufacturing companies. Some of these companies
perform well compared to others, and excellent operational performance renders into
good company fundamentals (Samad, 2015; Jahangir et al., 2007). As per the empirical
research works, the profitability of the companies provides an economic justification that
the company can continue its operation in the long run. It can help evaluate the financial
performance of the company by working as a crucial indicator. The different theories
placed by the financial management have concurred on the same ground that when the
shareholders want to maximise their wealth, the stocks have to maximise their stock
market value which is consequently ensured through the company management
effectively performing their operation. A successful business operation ensuring
long-term sustainable profitability can sequentially help shareholder wealth maximisation
(Besley and Brigham, 2007). Every business company operates with this objective in
hand. Moreover, this financial management objective is the foundation of all different
financing and investment decisions.
A company's performance in the stock market serves as a crucial indicator of its
operational performance as well as its market value. The market's reaction to the overall
financial performance, its efficiency, profitability, and other economic factors are
reflected in the share price. Initially, it is presumed that there is a direct association
(relationship) between a company's financial (profitability) performance and its share
price (return) reflected as the market value in the secondary (stock) market. The
374 M.M. Rahim et al.

apprehension on this causal relationship was based on the output of some seminal
research works in this field (Jorgensen et al., 2012). Nevertheless, the recent works on
this subject did not identify any robust association of a company's accounting financial
performance (profitability measures) with the stock price or return performance in the
secondary (stock) market. The result is not variable regarding whether profitability
performance is normal or abnormal (Liu and Thomas, 2000). Models which were
developed considering profitability measures and the stock price in the market did not
turn out to be efficient and significant. The R-square (R2) of the model was only 10%,
which demonstrated that the profitability measures were not capable of explaining the
stock prices or returns significantly (Al Ajlouni, 2009; Chen et al., 2007).
Growth in gross and net profit is also a very effective and widely used measure of a
business's overall performance. So, companies with high-profit growth have the potential
to ask for high market value from investors. That means the business corporations that
show promising growth in profitability variables yield a higher rate of return to their
investors. Various measures of profit growth are used in understanding company
performance (Fama and French, 2007). The main hypothesis of this analysis is that
profitability and profit growth can explain the movement of stock prices and their returns
(Alaagam, 2019; Bayrakdaroglu et al., 2017).
The objective of this paper is to find whether the stocks reflect any positive
relationship among the profitability and its growth variables with the overall stock
returns. The study examined whether the companies with high gross profit margin
(GPM), high operating profit margin (OPM), and high net profit margin (NPM) generate
a higher corresponding stock return and vice versa. In addition, examined if the
companies with high return on assets (ROA) and high return on equity (ROE) generate a
higher corresponding stock return and vice versa. Moreover, to test whether the
companies with high growth in gross profits and high growth in net profits generate a
higher corresponding stock return and vice versa. Based on the objective the study has
three research questions:
 Do stocks with a higher GPM, higher OPM, and NPM result in a higher
corresponding stock return?
 Do stocks with a higher ROA and higher ROE result in a higher corresponding stock
return?
 Do stocks with a higher year-on-year growth in gross profits and a higher
year-on-year growth in net profits result in a higher corresponding stock return?
Earlier researchers tried to find a causal relationship between the profitability variables
and the stock prices and value (Shawer and Al-Ajlouni, 2018). Several studies found a
positive relationship between the profitability variables and the stock prices (Jorgensen
et al., 2012). Nevertheless, some of the recent works did not find a robust and statistically
significant relationship between the profitability variables and the stock prices (return)
movement. The findings were true for both normal and unusual profits (Liu and Thomas,
2000). Some studies found that the independent profitability variables could explain 10%
of the dependent variable (stock price movement) as per R-square (Al Ajlouni, 2009;
Chen et al., 2007). Shawer and Al-Ajlouni, (2018) could not successfully conclude that
the profitability and the stock prices have any relationship. This study tests the
relationship among the profitability variables and the stock returns, instead of actual
stock prices. Stock return adjusted with the cash dividend, bonus, stock splits and right
 Impacts of profitability and growth on stock returns of the listed 375

shares are chosen as a variable to examine whether the investors are benefitted from
investing in companies with higher profitability. The stock prices decline because of
being adjusted with dividends and bonus (Sharma, 2011). So, it may not properly justify
the relationship between the independent profit variables and the stock price movement.
Moreover, earlier empirical works did not include the year-on-year growth in gross profit
and net profit in their models. It will be interesting to see through this study whether the
year-on-year growth in profit variables have any impact on the stock price movement as
well. In addition, few research were conducted to measure the impact of profitability and
growth with stock returns in Bangladesh. Specially, no research was conducted based on
the manufacturing sector of Bangladesh.
The first section presents the introduction, objectives and research aims, objectives,
and research questions. In the second section, the researchers' earlier findings on the
relationship between profitability and growth and stock returns are discussed under the
heading of literature review. Next comes the illustration of methodology, research
method or procedure, and data collection. Data analysis based on empirical data is
discussed in the analysis chapter. The major findings discussion follows it. Then a
concluding remark is made, including the recommendations and limitations of the study.
Any possible scope of further research is discussed at the end.

2 Literature review

A company discloses its financial information on scheduled periods of the year. There are
annual and quarterly disclosure of information to the shareholders–however, its stock
price changes from time to time, reflecting the fundamental attributes of the company.
The relationship between the fundamental variables and the stock return has seen
considerable research in the USA market. The profitability variables influence the future
returns and prices of stocks. Each of the fundamental profitability variables has different
sets of theoretical assumptions behind impacting the returns of stocks. These are proven
and justified through some notable and seminal research works in the past. However,
these relationships with all the variables are not altogether tested effectively in a market
like Bangladesh. The research works found a significant relationship among the earnings
variables with the stock return in the USA market. The results, however different,
justifies the reasoning behind affecting the stock return differently.

2.1 Theory development

The profitability variables, for instance, gross profit to asset ratio have the same
explanatory power as the book to market ratio regarding the cross-section of returns. The
variable also provides significant information economically, which is present in the
valuation of stocks (Novy-Marx, 2013). However, the outcome varies to somewhat extent
compared to earlier studies. Fama and French (2006) have found that the earnings
variable has predictive power in the cross-sectional returns of stocks. They suggested that
stock returns have a relationship with variables of the book to market equity ratio,
profitability, and higher investment rates. Though, Anomalies' (2008) found that
profitability generates the weakest form of hedged portfolio return among the
fundamental strategies considered. It cannot be concluded that unprofitable firms have
below-average low returns, although the profitable firms tended to make above-average
376 M.M. Rahim et al.

stock returns (Fama and French, 2008). Later, a five-factor model proposed by Fama and
French (2015) included value, size, profitability, and investment variables to capture the
cross-sectional return. This model also could not grab the low return of the unprofitable
firms who tend to invest more for the future. But they agreed that gross profitability has
more forecasting power than the net earnings variable over the future stock returns.
Similar predictive power of profits is also found on the future stock return (Ball and
Brown, 1968). Bernard and Thomas (1989) could not connect the exposed risk and the
associated raw returns. That is why the significant (abnormal) stock returns are not
necessarily anything abnormal considering the risk exposure, which is not estimated and
entirely explained by the asset pricing model. Ou and Penman also (1989a) stated that the
market does not reflect the fundamental information quickly. Furthermore, the future
stock returns get predictable because of this delayed market reflection of the earnings
reported by the firm (Dietrich, 1984; Dietrich and Wanzenried, 2014). The fundamental
(earnings) variable may have this predictive relationship with the future stock return
because of these issues.

2.2 Anomalies in stock returns and quality of earnings announcement

The patterns produced by future average stock returns are sometimes considered
anomalies. They are not correctly justified using the capital asset pricing model (CAPM)
proposed by Sharpe, the three-factor and five-factor pricing model by Fama and French,
and the Lintner Model. Some researchers think that these anomalies are caused because
of market inefficiency. This interpretation can be approached better by controlling for
some variables, such as the book-to-market ratio. It will say how much of the stock return
is explained by the irrational market pricing or rational risk. Cohen et al. (2002) found
that the firms more profitable have higher stock returns on average. Some researchers try
to justify anomalous stock returns with the quality of the earnings. Investors should be
willing to pay more price for the better quality of the firm. Better quality (earnings)
stocks produce above-average returns to a modest extent. So, taking a long position over
the better-quality stocks and selling the lower quality stocks produce substantial
risk-adjusted cross-sectional returns (Asness et al., 2019). On the other hand, if a
company stock has low-quality earnings, the stock yields a below-average future return.
If a firm's earnings are not backed by adequate cash flow, their earnings quality is
considered low quality rather than accruals.
Hypotheses are made on manipulating earnings, biasness of future growth, not
reacting well enough to the business fundamentals to understand the forecasting power of
the low-quality earnings (Chan et al., 2001). The role of accounting accruals' that the
accrual part of the earnings can explain future firm performance, which will be reflected
in the stock return. If the measurement interval is short, working capital, and capital
expenditure requirement is volatile, then the significance of earnings quality (accruals) in
determining the stock return increases (Dechow, 1994; Dechow et al., 2012). If the
earnings and asset growth are lagged and based on accruals, the profitability variable
produces average stock returns (Fama and French, 2006). Many researchers agreed on the
relationship of higher profitable firms generating higher stock returns. In addition, these
firms which invested more considerably produced lower than average returns (Fairfield
et al., 2003). Later, in many papers, researchers stressed that the accrual part of earnings
was responsible for average or below-average stock return by inferring lower future
earnings. The company loses its earnings persistence in the future because of the lower
 Impacts of profitability and growth on stock returns of the listed 377

cash flow generation (Dechow et al., 2012; Sloan, 1996). The gradual expectation can
explain this predictive nature regarding the future fundamental attributes of the company.
The market understands the quality and forecasts the future fundamentals. They reflect
the expectation through generating significant future stock returns. However, the market
does not respond systematically to earnings' reported quality (based on accruals and cash
flow and it reacts only when the present reporting affects actual earnings (Bernard and
Stober, 1989). In some cases, firms with low-quality earnings may produce confusing and
manipulative information to generate above-average stock returns in the future. The firms
try to influence future returns by reporting higher earnings numbers through accruals.
The managers use this signalling approach to boost share prices when this ‘accruals’
technique does not work and produces a higher stock return (Chan et al., 2007).

2.3 Market response of low-quality earnings and long run effect

A question may arise like why these false signals are not taken negatively by the market
and produce negative return performance in the long run. One argument may be that the
investors rely more on the earnings reported in the financial statements and less on the
overall business operation of the firm. Investors do not heed the earnings quality reported
in the financial statements when a firm declares share buyback programs. So, it is evident
that the stocks produce abnormal returns. However, in the long run, the situation is
different. With more understanding of the firms' intention, the market gradually loses the
earlier hype (Dechow et al., 2012; Sloan, 1996). This long-run return performance varies
according to different periods, markets, and economic conditions. Analysts give much
weight to the firm's gross profit or margin in determining the firm's future earnings
persistence. It is considered a less noisy variable in estimating future performance. So,
any increase in the gross profit/margin is taken positively and thus reflects positively on
the corresponding stock return performance. The long-run performance and the firm's
value are affected extensively through any variation (in either direction) in this
fundamental attribute (Bellovwy and Don, 2005; Lev and Thiagarajan, 1993).

2.4 Stock portfolio creation based on profitability of companies

The portfolio creation strategy based on the profitability of firms is a growth strategy.
Moreover, this strategy provides a good hedge for the value strategies as the returns from
the growth and value strategies are negatively correlated. So, the growth (profitability)
strategy generates above-average returns and provides the portfolio with somewhat
assurance for its value. When an investor adds a growth portfolio and the value strategy
to its portfolio, the overall volatility declines. Nevertheless, on top of that, the investor
gets twice the exposure on risky assets. In the end, it can be said that a value investor may
be able to capitalise on the gross profitability premium without taking any additional risk
if the investor gives more importance to the gross profitability when constructing the
portfolio (Novy-Marx, 2013).

2.5 Profitability variables impacting the stock return and its critical assessment
The GPM is a noteworthy feature of a good growth company stock. It is the indicator of
fundamental profitability with the highest tendency of generating cross-sectional returns.
The gross profitability can predict the stock returns, but that is not driven by the earnings
378 M.M. Rahim et al.

accruals or research and development expenditure. Gross profitability is a significant

forecaster of future returns with higher growth in gross and net earnings, free cash flow,
and other fundamental variables (Novy-Marx, 2013). If the profitability variable for the
stocks is controlled, then the value investment strategy performs better. The profitable
firms have more productive assets, which can be capitalised on better to produce more
return in the future (Barberis et al., 2005; Lakonishok et al., 1994). Zhang (2002) gives
the same explanation in his paper. If the firm's gross profitability is controlled, then most
of the earnings-oriented abnormalities can be explained, and so can be the unrelated and
different profitable trading strategies (Novy-Marx, 2013). Studies conducted in Japan do
not precisely match the USA. market results. A study was conducted by Chan et al.
(1991) with comprehensive datasets from listed and delisted securities from
manufacturing and non-manufacturing companies where the study concluded earnings,
size, cash flow, and book to market ratio have a significant relationship with the stock
return.
Any predictive profitability variable of future return is consistent in most of the
world's markets, but it may vary to some degree only. The findings, however, questioned
and exposed a significant failure in the efficient market hypothesis (Haugen and Baker,
1996). As outlined above, many papers have confirmed the profitable firms generate
higher stock returns. Nevertheless, papers did not justify whether the profitability
premium is because of rational pricing or irrational pricing. Wang and Yu (2013) tried to
work on this issue and opined that this premium depends considerably on the
firm-specific features and macroeconomic conditions. They found evidence that the
market under reacted the profitability information at the current period. Furthermore, it
was not generated by any traditional macroeconomic risk. Bayrakdaroglu et al. (2017)
conducted a panel data regression model among the profitability (independent) variables
and corresponding stock prices. The findings showed that the NPM positively affected
the stock prices of the companies. No other profitability variables showed any
statistically significant positive relationship with the stock prices. Therefore, the study
suggested to consider NPM variable before making any stock investment decision on any
company. In research in Indonesian market for the period of 2008 to 2011, Susilowati
(2015) found that ROA has a negative relationship with the corresponding stock price.
Moreover, NPM and ROE has a positive relationship with the stock price. The results
received in this study was statistically significant.
The paper will locate a relationship between a company's fundamental profitability
measures along with its growth variables and future stock returns. It may be possible to
put up a theoretical analysis of the relationships based on this paper. The independent
forecasting variables are inspired by the papers of the USA, Saudi Arabia, Turkey, and
Japanese stock markets. However, all the variables are not the same as the earlier works.
The GPM, OPM, NPM, ROA and ROE of stocks are considered as independent variables
inspired from recent empirical works (Shawer and Al-Ajlouni, 2018; Alaagam, 2019;
Bayrakdaroglu et al., 2017). Moreover, the gross profit and net profit year-on-year
growth rates are taken as the independent variables to examine if they positively impact
the stock returns. All the profitability and growth variables of the stocks are considered as
independent variables in the model developed in this paper. The corresponding yearly
stock returns are considered as the dependent variable in the developed model. In the
mentioned model, the co-efficient is expected to be positive. In the empirical studies,
there were differences in the actual results. So, it will be interesting to find out if the
expected relationship persists in case of Bangladesh market or not.
 Impacts of profitability and growth on stock returns of the listed 379

In earlier research works, researchers find a causal relationship between the

profitability variables and the stock prices and value (Shawer and Al-Ajlouni, 2018). The
hypothesis was built upon some previous works where the researchers found a positive
relationship between the profitability variables and the stock prices (Jorgensen et al.,
2012; Dwi Sihono and Widarti, 2021; Wijaya and Sedana, 2020). Nevertheless, some of
the recent works did not find a robust and statistically significant relationship between the
profitability variables and the stock prices (return) movement (Choiriyah et al., 2020).
The findings were true for both normal and unusual profits (Liu and Thomas, 2000).
Some studies found that the independent profitability variables could explain 10% of the
dependent variable (stock price movement) as per R-square (Al Ajlouni, 2009; Chen
et al., 2007). Shawer and Al-Ajlouni, (2018) could not successfully conclude that the
profitability and the stock prices have any relationship. The study will test the
relationship among the profitability variables and the stock returns, instead of actual
stock prices. Stock return adjusted with the cash dividend, bonus, stock splits and right
shares is chosen as a variable to examine if the investors are benefitted from investing in
companies with higher profitability. The stock prices decline because of being adjusted
with dividends and bonus (Sharma, 2011). It may not properly justify the relationship
between the independent profit variables and the stock price movement. Moreover, the
empirical works did not include the year-on-year growth in gross profit and net profit in
their models. It will be interesting to see if the year-on-year growth in profit variables
have any impact on the stock price movement as well.

3 Methodology and hypotheses development

3.1 Research approach and paradigm

In this paper, a deductive approach is taken into consideration to go through the work
process. Initially, the existing literatures are reviewed, and the hypotheses are analysed to
form hypotheses on this paper according to the deductive approach (Bryman and Bell,
2011). Then required amount of data will be collected from the respective different
sources. After necessary analysis, the results will be used to accept or reject the
hypotheses. These will be used to form the findings of this paper. Hair et al. (2007)
classified a study to be either explanatory, exploratory, or descriptive. The study is
expected to be classified under both explanatory and exploratory at the same time. It can
be classified as explanatory because it will describe why profitability measures impact
the corresponding stock return performance. The paper is also classified as exploratory
because it will determine any existing relationship between profitability and the stock
return. That is, whether stocks with higher profitability and growth provide a higher stock
return and vice versa.

3.2 Sampling method and data collection method

All the manufacturing companies listed in Dhaka Stock Exchange from 2014 to 2019 are
considered in the study. Thus, 198 companies are considered from 14 different industries.
The data are organised as panel data, which is the combination of cross-sectional
profitability and stock return data and time series data prolonging for six years period
(Alaagam, 2019; Shawer, and Al-Ajlouni, 2018; Bayrakdaroglu et al., 2017). If any
380 M.M. Rahim et al.

company fails to publish their annual report for a particular year, that is omitted for that
year and the subsequent year as the research model works with growth from one year to
another as well.

3.3 Hypotheses development

The hypothesis of the research is that the returns of the stocks can be explained by the
profitability ratios and profit growth rate of those companies. Based on the literature this
study will incorporate the following hypotheses:

3.3.1 Impact of GPM, OPM and NPM on stock return

GPM is used to calculate how much gross profit a company makes from its sales activity.
The larger the company's ability to cover operational expenditures and tax obligations
that must be paid, the higher the gross profit. In a study result on manufacturing
companies revealed that GPM is positively related to stock return (Dwi Sihono and
Widarti, 2021). Similar hypotheses were tested for OPM and NPM in a study on banking
companies of Indonesia (Choiriyah et al., 2020).
H1 There is a significant positive relationship among the GPM, the OPM, and the NPM
with the corresponding stock return.

3.3.2 Impact of ROA and ROE on stock return

ROA variable is used to assess the extent to which the companies utilise their assets
(Rosikah et al., 2018). Whereas ROE variable measures the extent to which the
companies capitalise on their shareholder’s capital. Several studies found has tested the
effect of ROA and ROE on stock returns. According to a study in Indonesia by Wijaya
and Sedana (2020), ROA is positively related to stock returns. Similar results were found
in several studies (Putra et al., 2018; Tyas et al., 2018). Moreover, ROE has a positive
impact on stock return in a study conducted on Indonesia food and beverage industry
(Adawiyah and Setiyawati, 2019). Parallel results were found in other studies (Anjani and
Syarif, 2019; De Kai and Rahman, 2018). Based on the literature, the study will test the
below hypothesis:
H2 There is a significant positive relationship among the ROA, and the ROE with the
corresponding stock return.

3.3.3 Impact of GPG and NPG on stock return

GPG is calculated by comparing the company's gross profit year over year. It aids in the
comparison of the company's gross profit to a previous fiscal year's benchmark number
(Winicki, 2019). In addition, the company's overall NPG is assessed by the increase in
net profit year over year. It aids in comparing the company's net profit to a benchmark
figure from the prior year, similar to GPG (Bayrakdaroglu et al., 2017; Winicki, 2019).
Earlier studies tested the effect of GPG and NPG on stock return (Bionda and Mahdar,
2017). The study will test the following hypothesis:
H3 There is a significant positive relationship among the GPG, and the NPG with the
corresponding stock return.
 Impacts of profitability and growth on stock returns of the listed 381

3.4 Variable definition

For finding the predicting power of profitability variables on cross sectional stock
returns, the independent variables are GPM, OPM, NPM, ROA, ROE, year-on-year GPG
and year-on-year NPG. Whereas the dependent variable is adjusted stock return.
 Dependent variable: The dependent variable of this paper is adjusted stock return
(Cengiz et al., 2016; Ercan et al., 2016). Researchers have used this variable for
finding a meaningful predicting power of the fundamental profitability variables on
stock return. Generally, the market takes some time to reflect the fundamental
information into the stock prices. So, the annual stock returns are calculated five
months after the end of fiscal year for each stock (Dietrich and Wanzenried, 2014;
Bernard and Thomas, 1989; Dietrich, 1984).
Dependent variable  Adjusted stock return ( Rs )

 Independent variables: Profitability variables are used as independent variables in

this model. These financial measurement indicators measure the firm’s ability to
produce net profit with respect to sales revenue, operating profit with respect to sales
revenue, gross profit with respect to sales revenue, net profit with respect to total
assets and total shareholder’s equity, and year-on-year net profit and GPG for a
certain period (Alaagam, 2019; Bayrakdaroglu et al.,2017, Lesakova, 2007; Shawer
and Al-Ajlouni, 2018).
Independent variable  Gross profit margin(GPM )
operating profit margin(OPM )  Net profit margin( NPM )
+ return on assets( ROA)  Return on equity ( ROE )
Gross profit growth(GPG )  Net profit growth( NPG ).

 GPM: GPM measures the portion of gross profits of a company with respect to the
generated total sales revenue. The greater the GPM, the better the company’s
capability of generating gross profits from its sales revenue, after adjusting for the
cost of goods sold. It is measured as the ratio of gross profit with respect to the
company’s total sales revenue (Bayrakdaroglu et al., 2017; Cengiz and Puskul,
2016).
 OPM: OPM measures the amount of generated operating profits with respect to the
total sales revenue. The operating profit is obtained after the operating expenses are
adjusted from the gross profits revenue (Bayrakdaroglu et al., 2017; Cengiz and
Puskul, 2016).
 NPM: NPM measures the portion of net profits of a firm with respect to the total
sales revenue. The greater the NPM, the better the company’s capability of
generating net profits from its sales revenue. It is measured as the fraction of net
profit with respect to the company’s sales revenue (Alaagam, 2019; Winicki, 2019).
 ROA: ROA variable is used to assess the the extent to which the companies utilise
their assets (Rosikah et al., 2018). Specifically, it measures the level of income a
company makes against one unit of total asset. This variable can be calculated by
dividing the net profit after taxes by the total assets of the company (Brigham and
Houston, 2001).
382 M.M. Rahim et al.

 ROE: ROE variable measures the extent to which the companies capitalise on their
shareholder’s capital. The variable measures the level of earnings the company
generates per unit of capital. It is shown as a return percentage to the shareholder’s
capital (Lesakova, 2007). ROE is a benchmark for measurement of financial
performance for a company.
 GPG: The GPG is measured through the year-on-year growth of gross profit of the
company. It helps to evaluate the gross profit of the company against a benchmark
value taken from the previous fiscal year (Winicki, 2019). The GPG variable is not
used that much on empirical research works. So, the extent of this variable affecting
the dependent variable and considering this variable before making any stock
investment decision is assessed here.
 NPG: The overall NPG is measured through the year-on-year growth of net profit of
the company. It assists to evaluate the net profit of the company against a benchmark
value taken from the previous year, similar to the GPG (Bayrakdaroglu et al., 2017;
Winicki, 2019). The variable is not researched that much on empirical works. The
variable may produce meaningful result like NPM that affects the stock prices/return.
The data definition and the expected relationship between the independent variables and
the dependent variable are shown as follows:

3.5 Research design

The multiple regression model developed in this study will try to describe the relationship
between the study (independent and dependent) variables. The study model suggests the
adjusted stock return as a dependent variable, and GPM, OPM, NPM, ROA, ROE, GPG,
and NPG independent variables.
The research model is shown as follows:
Rs    1GPM   2 OPM  3 NPM   4 ROA
(1)
 5 ROE   6 GPG   7 NPM  ε 

where
 constant term of model
1,2,3,4,5,6,7 model parameters
Rs adjusted stock return
GPM gross profit margin
OPM operating profit margin
NPM net profit margin
ROA return on assets
ROE return on equity
GPG gross profit growth
 Impacts of profitability and growth on stock returns of the listed 383

NPG net profit growth

 error term of model

4 Findings and analysis

4.1 Summary statistics

The descriptive statistics of all the dependent and independent variables in the model are
shown as follows:
Table 1 demonstrates the summary (descriptive) statistics of all the variables,
including dependent and independent variables incorporated in the model. In this
presentation, the number of observations, the average (mean) values, the standard
deviation, the minimum and maximum values, skewness, and the kurtosis of each
individual variables are shown (Alaagam, 2019; Bayrakdaroglu et al., 2017; Shawer, and
Al-Ajlouni, 2018).
The adjusted stock return of the manufacturing companies moves around an average
value of –78.1%. The dispersion of the stock return values range within the standard
deviation of 24.15. Minimum value of –747.5 shows that there are some outlier return
values which dragged down the mean return. The maximum return value is seen to be
46.4%. In terms of skewness, the return variable is mainly inclined to the left. The high
kurtosis value shows that the variable is steeper compared to the normal distribution.
The GPM measures the amount of gross profit per the sales revenue of a company.
The mean GPM is 4.99. The variable has wide dispersion across the standard deviation of
49.49. The minimum value of –59 and maximum value of 549 shows that the mean value
is affected very much by the outlier values. The skewness of more than nine shows that
the variable is tending more towards the right. The kurtosis value shows steeper
composition.
The OPM is 3.13 on an average. The measure varied with a standard deviation of
35.5. The minimum and maximum values are –222.2 and 532.7 respectively. These
values have surged up the average value to a great extent.
The mean NPM value is equal to 0.023. The dispersion is low with a standard
deviation of 1.14. The minimum and maximum values are within a small range unlike the
earlier two variables. The variables are inclined towards the left as depicted by skewness
of –15.6.
The ROA centred on the value of 0.046. Most of the companies have the similar
values as demonstrated by the low standard deviation of 0.095. The minimum and
maximum values are –1.15 and 0.47 respectively. Similarly, the ROE has a mean value of
0.58. The standard deviation is around 5.23. Comparatively, ROE has a wider range than
ROA. The minimum and maximum values are –1.37 and 88.58. The ROA skewed
towards the left and ROE skewed towards the right shown by values of –4.6 and 12.7
respectively.
The growth in gross profits and net profits variables have shown high mean values of
–6.6 and –28.3 respectively. Both the variables have shown considerably wide dispersion
of values. The high minimum and maximum values infer that the average is biased by the
outlier values.
384 M.M. Rahim et al.

Table 1 Summary statistics

Standard
Variable Observations Mean Minimum Maximum Skewness Kurtosis
deviation
Stock 993 –0.78133 24.14735 –747.5072 46.37857 –29.96331 923.5432
return
Gross 816 4.99776 49.4923 –59 549.0298 9.99075 101.5813
profit
margin
(GPM)
Operating 803 3.13153 35.49168 –222.2412 532.7327 9.52112 117.1473
profit
margin
(OPM)
Net profit 811 0.02307 1.13869 –25.33088 6.14205 –15.57684 323.9494
margin
(NPM)
Return on 812 0.04624 0.09595 –1.14723 0.47496 –4.60174 61.2845
assets
(ROA)
Return on 784 0.58168 5.23044 –1.37202 88.5812 12.73728 175.7934
equity
(ROE)
Gross 984 –6.5929 151.6932 4575.104 58.30303 –28.25631 840.5144
profits
growth
(GPG)
Net profit 975 –28.275 835.0864 –26023.18 132.5294 –30.99154 964.9866
growth
(GPG)

4.2 Panel data model

The panel data model estimation was employed in this study to control individual
heterogeneity and multicollinearity. The model had no multicollinearity and
autocorrelation problem. The Variance Inflation Factor test is also done to check for the
multi-collinearity problem in the model. The VIF test shows that the model does not have
any multicollinearity problem. So, there is no problem in going ahead with this model.
Besides, no independent variable needs to be dropped from the model to ensure
robustness. The Breusch Pagan Test is done to check for the heteroscedasticity problem
in the model (Bayrakdaroglu et al., 2017). The test output is shown as follows in Table 2.
The Breusch-Pagan test for Heteroscedasticity results indicate that the hypothesis (H0)
should be rejected. It implies that the variance of the unit effects is equal to zero. That is,
the model does have heteroscedasticity problem. The result is confirmed by assessing the
probability value, which is significant at 1% significance level. If the model has any
heteroscedasticity problem, then it will not be right to interpret the pooled OLS multiple
regression model (Bayrakdaroglu et al., 2017; Kartikasari and Merianti, 2016). The
model should be adjusted for Heteroscedasticity or alternatively there are other regression
models. Therefore, the model should be developed using some other regression procedure
designed specifically for panel data. There are two major regression models for panel
 Impacts of profitability and growth on stock returns of the listed 385

data- fixed effect regression model and random effect regression model (Kartikasari and
Merianti, 2016).
The models where the Hausman test estimates are significant represents that the
p-value of chi-square is less than 0.05, signifying that the fixed effect model (FEM)
should be used. Hausman test is conducted to find out which model between fixed effect
regression model and random effect regression model should be chosen for interpretation
(Shawer and Al-Ajlouni, 2018; Kartikasari, and Merianti, 2016). The Hausman test
estimates indicates that between the developed fixed effect regression model and random
effect regression models, random effect regression model is more suitable. Here, the
probability (p-value) value is higher than 0.05 (5%) or 0.1 (10%). In this study, random
effect regression model estimates are considered more appropriate. Therefore, we
interpret the random effect regression model.

4.2.1 Random effect regression model

The random effect regression model considering Stock Return as the dependent variable
and GPM, OPM, NPM, ROA, ROE, year-on-year GPG and year-on-year NPG as the
independent variables is shown as follows.
Table 2 Random effect model

Model
Variables
Coeff. Std. err. t-stat P>|t|
GPM 0.00056 0.00534 0.11 0.916
OPM 0.00085 0.00457 0.19 0.852
NPM 0.03974 0.08033 0.49 0.621
ROA 1.20272 1.01871 1.18 0.238
ROE –0.00571 0.02150 –0.27 0.790
Gross profit growth 0.00044 0.00053 0.83 0.407
Net profit growth 0.02860 0.000095 299.45 0.000
_cons 0.09199 0.11116 0.83 0.408
R-squared 0.9933
Prob > F 0.0000
Observations 638
Hausman 0.9850 (REM)

Table 2 represents the random effect regression model showing the relationship among
the various independent variables and the dependent variable adjusted stock return. The
model is seen to robust as measured by the R square of the model being 0.9929. It implies
that the profitability variables account for 99.29% of the total variation in stock return
variable. The result is similar to that of the fixed effect regression model output. The
result is based on 638 observations, similar to the earlier two model output. The
F-test shows that the random effect regression model is statistically significant at 1%
significance level. The probability value (p-value) for the F statistics is less than 0.01,
equal to 0.000. Therefore, interpreting this model and the corresponding test of
hypotheses is valid and justified (Kartikasari and Merianti, 2016). The intercept
(constant) of the random effect regression model has a positive coefficient of 0.09199. As
386 M.M. Rahim et al.

mentioned before, the value of intercept refers to the change in the dependent variable,
here in this model by 0.09199% in the same positive direction, without having the
respective independent variables affecting the dependent variable. Nevertheless, the
t-statistics is 0.83, which is not statistically significant. It is below the range of 1.65 and
1.96 applicable for 90% confidence interval, so the intercept is not significantly different
from 0. Moreover, the probability (p-value) value is 0.408, greater than 0.10. It does not
infer a statistically significant output. Here, like the earlier models, NPG shows a
statistically significant positive relationship with the dependent variable, stock return.
The co-efficient is positive 0.02860, which implies a positive relationship. The
p-value is 0.000, less than 1%. It means that the result is statistically significant at 99%
level of confidence. The other independent variables apart from the ROE variable also
demonstrates a positive association with the dependent variable, stock return. The
relationship between the ROE and the stock return is negative. However, the results are
not statistically significant as showed by the t-statistics and p-value.

4.3 Discussion
The output of the random effect regression estimates demonstrates that the association of
the profitability measures and the corresponding stock prices is very high, as shown by
the R-square (R2) of the model. The independent variables can explain more than 99% of
the variation in the dependent variable. However, the relationships are not statistically
significant except for the NPG variable. In empirical works, researchers found a linear
association between the NPM and the stock prices (return) according to their models
(Akyatan, 2016; Bayrakdaroglu et al., 2017; Şamiloğlu et al., 2017). Nonetheless, Sevim
(2016) concluded no statistically significant relationship among the profitability
measures, such as NPM, ROA, as well as ROE with the stock prices (return). Another
research is done by Shawer and Al-Ajlouni (2018) on some of the manufacturing
companies concluded that the profitability measures did not correctly reflect on the
corresponding share prices in the market.
In this study, the GPM, NPM, ROA, GPG, and NPG showed a positive but
insignificant association with the stock return variable while the ROE has no significant
effect on stock return. As examined earlier, only the impact of the NPG variable is
statistically significant at a 1% level with a p-value of 0.0000. The coefficient is 0.02859.
It means that if the NPG variable changes by 1%, then the stock return changes by
.02859% in the same direction. The overall positive relationship suggests that when the
NPG of a stock increases, then the corresponding adjusted stock return of the firm
increases and vice versa. The explanatory power of other profitability variables (except
for OPM) may have matched the expected positive sign. However, the statistically
insignificant result cannot emphasise the robustness of those relationships.
The explanation of the insignificant relationship may be justified based on the
investor dynamics in the Bangladesh market. The retail level investors dominate the
market instead of the institutional investors. They seem to take their investment decisions
without considering any professional level analysis of the stock. Lack of expertise and
experience compared to professional, institutional investors result in such random
investment decisions. The unexpected negative association with OPM may also result
from non-analytical decision-making.
Most retail-level investors look for instant profits in the secondary market. They
make investment decisions as speculators without the foundation of any professional
 Impacts of profitability and growth on stock returns of the listed 387

expertise. So, the decisions are not backed by the financial performance and
value-generating activities of the companies (Islam et al., 1996). The context can be
justified more if the findings are compared with any other market with similar
demographics. In Saudi Arabia, the presence of individual-level investors is higher than
the institutional-level investors who do not back any investment decision with proper
financial and profitability analysis. The stock return was not significantly impacted by the
profitability measures in that region as well (Shawer and Al-Ajlouni, 2018).

5 Conclusions

The paper mainly examined, if the profitability measures and growths of stocks have any
impact or association on the adjusted stock return of the manufacturing companies listed
at the Dhaka stock exchange in Bangladesh during the period of 2014–2019. Regression
models were developed to assess the expected relationships among the GPM, NPM,
OPM, ROA, ROE, GPG, and NPG, and the adjusted stock return. The random effect
model was selected based on the Hausman specification test results. The study included a
panel data sample of 198 manufacturing companies operating in 14 industries listed in the
Dhaka Stock Exchange from 2014 to 2019.
The study output concluded that the manufacturing companies' stock returns did not
significantly reflect the profitability features. As suggested by statistical insignificance,
the secondary market stock prices did not strongly react to the announcement of financial
profitability information. The association is weak, and the underlying studied elements do
not influence the investor's investment decision. Nevertheless, the investors value the
growth of net profits in giving more market value to the stocks. The strong positive
impact of NPG on the stock return justifies this outcome. The positive relationship among
other profitability ratios and the stock return has not turned out to be robust and
significant. The reasoning may be because of the speculative and non-analytical
investment decision-making by individual-level investors. In developing countries like
Bangladesh, investment practice in the capital market is relatively new. There are
institutional voids in ensuring market transparency and investor’s decision does not
depend totally on operating performance of listed firms. Non-market phenomenon such
as reputation, historic performance and transparency in disclosures of the relevant firms
might play an important role in investment decision process of investors in the secondary
market and hence the value of stock returns. Otherwise, like other empirical studies, the
GPM and NPM could have significantly accounted for the market stock prices. The ROA
and ROE were also expected to impact the stock returns.
Working on the growth and profitability on the stock returns in the Bangladeshi
market has added a new dimension to the understanding of stocks' market value to a great
extent. The study did not manage to fully accept the hypotheses that were built while
developing the model. However, the study has managed to add a new paradigm on
investment decision-making justification based on the financial performance of the
stocks. The output will support the stakeholders, shareholders, portfolio managers, and
researchers in classifying the underlying factors essential for consideration when making
investment decisions in Bangladeshi manufacturing companies.
388 M.M. Rahim et al.

5.1 Limitations and future research directions

The study on the stock’s profitability and its stock return are susceptible to some
limitations. The study has been limited to six years of data which made some constraints
in implementing and developing some advanced models. The study could be extended for
more than ten years, or preferably twenty. In that case, the long-run association of the
subject could have been tested for the manufacturing companies in Bangladesh.
Empirical researchers had developed and followed the panel ARDL method when they
worked with an extended period of panel data. It may have been possible to apply such
models and add to the depth of the research. More financial and profitability variables
can be added to the model in the future, and some control variables may also be added to
examine the predicting power of the profitability variables when explaining the stock
returns or prices

5.2 Theoretical contribution

The study’s main objective is to find out the impact of profitability and growth on stock
returns. Earlier studies mainly focused on the profitability indicators like ROA, ROE,
NPM and OPM. This study checked whether the year-on-year growth in profit variables
have any impact on the stock price movement as well. In addition, few research were
conducted to measure the impact of profitability and growth with stock returns in
Bangladesh. Specially, no research was conducted based on the manufacturing sector of
Bangladesh.

5.3 Managerial implications

The study output will help the investors and stakeholders to take stock investment
decisions more diligently. The financial information of the companies should be coupled
with other macro-economic, market-specific, and company-specific factors before
making investment decisions. The market should encourage financial literacy among the
investors to make educated investment decisions after efficiently evaluating the
company-specific profitability and value information. Mutual funds should encourage
retail investors to invest in stocks through their funds to refrain from unnecessary
speculative stock buying decisions. The companies should ensure quality earnings
information to the investors so that there is no confusion whatsoever. The regulators and
policymakers should encourage policies so that institutional investors have more
participation in the secondary market instead of individual-level investors.

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