The Effects of ROE Factors by New Decomposition Method on the Stock Price in Korea KOSPI Market

Transcription

1 The Effects of ROE Factors by New Decomposition Method on the Stock Price in Korea KOSPI Market Changrae Park, Department of Accounting, Gangneung-Wonju National University, South Korea. Taewan Kim, Department of Accounting, Gangneung-Wonju National University, South Korea. Abstract ROE is regarded as a comprehensive measure of a firm s performance because it provides the performance information related to product market strategies and financial market policies. To measure the overall profitability of a firm, ROE is decomposed into ROA, as the measure of market strategies performance, and into equity multiplier as the measure of financial market polices performance. Moreover, the ROA is also decomposed as return on sales and assets turnover. However, this traditional approach has some limitations. Therefore, the new approaches are on the rise. In one of them, ROE is decomposed as return on business assets and financial leverage effects. The return on business assets is further decomposed as return on operating assets (ROOA) and return on investment assets (ROIA), and financial leverage is decomposed as spread and financial leverage. The purposes of this study were to investigate the effects of ROE decomposition factors which is decomposed by the new approach on the common stock price of the firms listed in Korea KOSPI market. First, this study reviews the effects of ROOA, ROIA, and debt ratio on the firm s stock price for the all sampled companies. Second, this study analyzed whether the stock price effects of ROE and ROE factors were influenced by the ROOA level. 5,939 manufacturing companies were sampled out from the Korean KOSPI stock market list between 2001 and The results of this study were as follows. First, while the stock price showed negative relationship with ROIA and the debt ratio, it showed a positive relationship with ROE, ROOA, and Size. Second, while ROE showed positive effect to the stock price in the case of analyzing all sample companies, it showed positive effect only in groups with low ROOA and did not give significant effect on middle and upper levels of ROOA. Third, as a factor of ROE, ROOA had influence on the stock price but the sign of regression coefficients was different depending on the level of ROOA. Fourth, debt ratio showed negative effect on stock price in all cases. Fifth, ROIA showed positive effects on stock price only in the case of all sample analysis and the group of higher level in ROOA. Sixth, size showed positive effect on stock price in all cases. Key Words: ROE (return on equity), return on operating assets, return on investment assets, stock prices effect of ROE components, stock prices effect of return on operating assets, stock prices effect of return on investment assets. JEL Classification: G32, M41 1

2 1. Introduction Proceedings of the Tenth European Academic Research Conference on Global Business, The major task of the manager is to enhance the performance of the company. So the performance of company is regarded as the performance manager. There are many ways to evaluate the performance of managers. Performance evaluation can be divided into two methods - qualitative methods and quantitative methods. When using the quantitative methods, the ratio analyses are widely used. The data used for the ratio analyses comes from financial statements. Analysts evaluate the performances of manager by interpreting the calculated ratios. Analysts calculate the financial ratios by matching two financial items. By converting the financial statements information into ratios, analysts and accounting information users can evaluate the past performance of the company they are analyzing. Traditionally, ratio analysis was applied to historical data to evaluate past performance. However nowadays, ratio analyses also are used to evaluate the plausibility of forecasted financial statements and the valuation of the company (Lundholm and Sloan, 2013). The major tasks of a manager are related to financing and to investment of financed fund for the profit of the company. The performance of a manager is related with the financial market policies and product market strategies (Palepu, Healy, and Peek, 2013). So manager should make decisions about for kinds of areas operating management, investment management, financing strategies, dividend polices. Ratio analyses focus on the evaluations of effectiveness of the firm s policies of these areas. Because ROE shows how efficiently funds are used when invested by the firm s shareholders in order to generate returns, it is regarded as the comprehensive indicator of a firm s performance. ROE is also decomposed into return on assets (ROA) and a measure of financial leverage. The former is related with products market strategies and the latter is related with financial market strategies. Because of that, ROE and ROE decomposing factors are popularly used for the evaluation of manager s performance. However, this traditional approach has several limitations. There is a mismatch between the numerator and denominator in calculating decomposed factors. So alternative approaches were on the rise. According to new approach, ROE is decomposed into a return on business assets and financial leverage effects. The return on business assets(roba) is further decomposed into return on operating assets (ROOA) and return on investment assets (ROIA), and financial leverage is further decomposed as spread (the difference between ROBA and effective interest rate) and financial leverage (debt ratio). There are three kinds of stock markets in Korea KOSPI, KOSDA, and KONEX. Among them, KOSPI, which was open in 1956, is the most popular and the first financial market and the typical stock market in Korea. Because of this reason, the stock price related researches in KOREA are usually focused on the KOSPI market. 2

3 The purposes of this study are to investigate the effects of ROOA, ROIA and debt ratio as financial leverage on the stock price of listed firm in Korea KOSPI stock market. First, this study reviews the effects of ROOA, ROIA, and debt ratio on the stock price of overall manufacturing companies listed in KOSPI. Second, this study examines the effects of ROOA, ROIA, and debt ratio on the stock price according to the ROOA level. 2. Literature Review 2.1 ROE Decomposition Methods Traditional Approach Managers make decisions regarding not only the operating activities but also financing activities which affect the earnings for the shareholders. Operating activities are related to product market strategies and produce operating income. Financing activities are related to financial market polices and produce financial income. Both the return from operating activities and the return from financial activities compose the overall profit of the company. Because ROE evaluates overall efficiencies of employing the financed funds from the owner, ROE is regarded as a comprehensive indicator of firm s performance. Traditionally, ROE is decomposed into its two drivers return from operating activities and return from financial activities. So the first level of decomposing ROE is to distinguish the profitability of these two activities. The second level of decomposing is to decompose return from operating activities into the sub-derivers. The return from operating activities can be further decomposed into profit margin and asset turnover, as follows; ROE = Net Income = = ROA Multiplier Net Income Total Assets Total Assets Equiry = Net Income Sales Sales Total Assets Total Assets = Net Income Sales Sales Total Assets Total Liabilities + = Net Income Sales Sales Total Assets Total Liabilities (1 + ) In traditional approach, ROE can be decomposed into return on sales (ROS), asset turnover and leverage. ROS shows how much the company can get profit for each dollar of sales the company makes. Asset turnover shows how much sales of money can generate for each dollar 3

4 of assets investment. So the ROS indicates the profitability from sales activities and the asset turnover indicate the efficiencies of assets investment. multiplier indicates the financial structures. multiplier indicates how much money of the assets can deploy for each dollar invested by the owner. multiplier indicates not only the leverage effect of debt, but also the financial stability. Therefore, ROE can be decomposed into profitability, activity, and financial stability indicators. In this aspect, ROE is regarded as a comprehensive measure for the overall profitability Alternative Approaches Though the traditional decomposing method is popular among the analysts, this method has some limitations (Lee, 2016). First, when computing the return on assets (ROA), the numerator includes only the net profit which is available to owners, while the denominator includes all the providers of capital to the firm. So there is a mismatch between the numerator and denominator in calculating ROA. Second, when computing the ROA as the measure of operating activities, total assets as the denominator include not only the assets applied to operating activities but also the assets applied to investment activities such as excess cash and marketable securities. According to the traditional approach, the denominator for calculating the ROA includes both operating assets and financial assets. So ROA can t properly measure the operating performance itself. Third, net profit, which is the numerator for calculating ROA, also includes both the performance of operating activities and that of financial activities such as interest income and expenses. Net profit, which is reported in income statements, includes all the results of operating decision and financial decision. Fourth, there are some mistakes in calculating financial leverage. Traditionally, financial leverage has been calculated by comparing the total liabilities and owner s equity. However, the operating liabilities such as account payables are included in liabilities. And some assets such as excess cash and marketable securities may be regarded as negative liabilities because those assets are surplus funds which can be used for repaying the liabilities. So investment assets (including surplus funds such as excess cash and marketable securities) should be deducted from liabilities in order to correctly calculate the equity multiplier and operating activities performance. In addition to that, it is not commonly believed that there are noninterest bearing liabilities in total liabilities. For those reasons, alternative approach was on the rise. New approach decomposes the ROE as operating ROA (return on net operating assets), financial leverage, and operating spread (Penman, 2010), as follows; 4

5 ROE = Proceedings of the Tenth European Academic Research Conference on Global Business, Net Income = ( NOPAT Net Assets = NOPAT Net Assets = NOPAT NIEAT Net Assets Equiry ) ( NIEAT Net Debt (1 + Net Debt ) ( NIEAT Net Debt Net Debt Equiry ) Net Debt Equiry ) = Operating ROA + (Operating ROA EIRAT) Net Financial Leverage = Operating ROA + (Spread Net Financial Leverage) In here, NOPAT: net operating profit after tax NIEAT: net interest expense (interest expense interest profit) after tax Net debt: interest bearing debt excess cash and marketable securities EIRAT: effective interest rate after tax However, this new approach also has other limitations. The investment assets and surplus funds are deducted from all the interest bearing liabilities for calculating the net financial leverage (net debt). However, operating, investment, and financing activities contribute differently to a firm s performance, and their relative performance may vary across the time and firms (Palepu et al, 2013). For the ROE decomposition, it is useful to properly distinguish the operating performance, investment performance, and financing performance. When comparing upper mentioned alternative approach, this method separates the investment performance. This alternative approach decomposes the ROE into ROBA (return on business assets), financial leverage, and spread (Palupe et al, 2013), as follows; 5

6 ROE = Proceedings of the Tenth European Academic Research Conference on Global Business, = = NOPAT + NIPAT = ( BA Net Income NOPAT NIEAT NOPAT + NIPAT IEAT BA ) (IEAT Debt Debt ) NOPAT + NIPAT = ( BA ) (1 + Debt ) (IEAT Debt Debt ) = ROBA + (ROBA Effective Interest Rate) Financial Leverage = ROBA + (Sperad Financial Leverage) In here NOPAT: net operating profit after tax NIPAT: net investment profit (investment income + interest income) after tax IEAT : interest expense after tax BA: business assets (operating assets + investment assets which include excess cash etc.) Debt: interest bearing debt ROBA: return on business assets ROBA is the performance of operating and investment activities. Spread is the effect of debt financing, and this effect is positive as long as the ROBA is greater than financing cost. ROBA can be further decomposed into ROOA (return on operating assets) and ROIA (return on investment assets), as follow; ROBA = NOPAT + NIPAT BA = ( NOPAT OA OA BA ) + (NIPAT IA IA BA ) = (ROOA OA BA ) + (NIPAT IA IA BA ) In here ROOA: return on operating assets ROIA: return on investment assets OA: operating assets 6

7 IA: investment assets This new alternative decomposition method considers the different contribution of each driver to firm s performance and can be used to forecast and value the company. Furthermore, this decomposition also provides information about the different relative importance among operating performance, investment performance, and financing across the companies. 2.2 Researches about ROE and its Decomposition Factors ROE and its decomposition factors are used for the performance evaluation, performance forecasting, and prediction of portfolio performance (Mainul Ahsan, 2011). For the forecast of ROE, ROE behavior along the passing time was reviewed (Penman 1991; Fama and French, 1995). Kijewska (2016) reviewed the decomposition factors of ROE and identified which factors are determinants of ROE growth and decline in Poland. Kwon (2002) examined that the reclassification of income statement items had predictive contents in forecasting ROE. The firm s value relevance of ROE was examined after the IFRS adoption in Korea (Chung and Lee, 2012), and the relationship between the decomposed factors of ROE and the future profitability and value relevance was also examined (Kwon and Moon, 2009). Heikal et al (2014) reviewed whether the financial ratios including ROE had influence on the corporate growth in Indonesia Stock Exchange. However, ROE is not panacea for the performance evaluation (De Wet and De Toil, 2007). In the case of European bank ROE may be lather an element of incentive in the relationship between banks and markets than performance measure (ECB, 2010). There are many literatures about the ROE and its decomposition factors in academic and practical areas. And ROE has been used for the measure of manager s performance. However, the research about the effects of ROE decomposition factors by newly arisen method on stock price is little. 3. Methodology 3.1 Research Questions As indicated in introduction, the major research questions are to investigate the effect of ROOA, ROIA, and debt ratio on the stock price and to investigate the effect of ROOA ROIA, and debt ratio on the stock price according to the ROOA levels in each Korea KOSPI market. First, this study reviews the effect of ROOA ROIA, and debt ratio on the stock price of manufacturing companies. As upper contents have mentioned, ROBA, which is the measure of operating performance of manager, is affected by the decisions of manager. So the ROBA may influence on the value of the company - the stock price. As like ROBA, the financial leverage which is the measure of financial decision of manager may also influence on the value of company - the stock price 7

8 ROOA and ROIA are the further decomposition factors of ROBA. So the ROOA and ROIA also may influence on the stock price. However, the ROOA is related to investment to the operating assets and ROIA is related to investment assets. So the performances of operating and investment may influence differently on the stock price. In this aspect, reviewing and comparing the effects of ROOA and ROIA on the stock price is critical. Financing activities may influence the performance of company. Financial activity factors of ROE are spread and financial leverage. The spread is the difference between ROBA and effective interest rate after tax. So the spread is influenced by the financial risk which is related with financial leverage. Because of that the debt, ratio as the proxy of financial leverage may influence the stock price. Second, this study examines the effects of ROOA, ROIA and debt ratio on the stock price by the ROOA level. The performances of operating assets and investment assets may influence deploying financed fund to each assets. If the companies have relatively higher ROIA than in other companies), there may be differences in allocating the financed fund and financing activities. However, according to the former research (Park, 2017) managers want to balance performance between operating and investment. Managers may allocate the resources to the operating assets until the operating performance reaches to the proper level. For these reasons, available funds are allocated to the operating assets first, and the remaining are allocated to the investment assets to balance the performances between operating and investment. So the stock price effect of ROOA, ROIA, and debt ratio may be different according to the ROOA level. 3.2 Analyses Method This paper reviewed the effect of ROOA, ROIA, and debt ratio on the stock price and examines the ROOA, ROIA, and debt ratio on the stock price according to the ROOA level. First, for the analysis of ROOA, ROIA, and debt ratio on stock price, regression method was used. ROOA, ROIA, and debt ratio were regressed on the stock price for the all sample. For reviewing the effect of these variables on stock price, the sign and the significant level of regression coefficients were reviewed. Second, samples were grouped as 3 even deciles according to the ROOA for each year. For example, all the KOSPI listed samples of year 2001 were grouped as 3 even deciles according to the ascending order of ROOA. The regression coefficients of ROOA, ROIA, and debt ratio were compared among the ROOA deciles lower, middle, and higher group of ROOA. The size (Ln_Size) and year (year dummy) were sued as control variables in all regression analyses. 8

9 3.3 Research Model This research used regression model. The stock price at the end of financial statements disclosure month was used as explained variables, and ROOA and ROIA were used as explanatory variables. The models for the analysis are as follows. P it = α 0 + α 1 ROOA it + α 2 ROIA it + α 4 DEBT it + α 5 Ln_Size it + α 6 YearDummy it + ε it In here P it : Firm i s per share price at the end of financial statements disclosure month divided by par value ROOA it : Firm i s ROOA for period t ROIA it : Firm i s ROIA for period t DEBT it : Firm i s Debt ratio for period t LnSize it : Firm i s ln(total assets) for period t YearDummy it : Year dummy for controlling year effect Because the par value of listed company is not same, it was needed to control the difference of par value. In this research, common stock price was divided by par value for controlling the par value difference. And the stock price is influenced by firm size. So the natural log of total assets were included in the regression model as control variable. In this research, the analyzed companies were included in manufacturing industry and fiscal year was ended in December. In addition, almost all companies were disclosed financial statements at the 3 rd month after the fiscal year end. So stock price is measured at the end of the March in the next year in order to use the stock price that fully reflects the year t s financial statements. The ROOA, ROIA, and debt ratio were ratio variables which were calculated by using financial statements. So these variables were more able to have extreme values (outliers). In order to the control the effect of outliers, all the variables are winsorized by 1%. 3.4 Data The samples were selected from the manufacturing firms which were listed on the KOSPI between 2001 and 2015 and ended fiscal year in December. Financial statements data for calculating ratios extracted from NEW KIS-VALUE Ⅲ database. Total sample size was 5,939 firm-years. Sample size of 2001 was the smallest and those of 2015 were the largest. This was the results of new IPO companies. 9

10 Table 1: The Distribution of Samples by Year YEAR Frequencies Percent Total 5, Results and Discussion 4.1 The Descriptive Statistics of Variables The descriptive statistics of variables are presented in [Table 2]. All the variables were winsorized by upper and lower 1%. The statistics of [Table 2] are the results of the analyses of the winsorized variables. The mean of stock price was times of one unit of par value (1 Korea won: 1), and the median was times. This means that although the stock price was times more than the average compared to the par value, when compared to the median, companies with relatively high stock prices existed. That means a few companies with comparably high stock prices existed. The average of ROE was 2.468%, which indicates that a firm s net profit was approximately 2.468% of the equity which was not much profit compared to the equity itself. However, median was 5.560% which was relatively higher than the average. This indicates that quite a number of companies with relatively low ROE existed. The minimum value of ROE was -218,140%. This means that the lowest performance companies had become the status of impairment of capital. The average of ROOA was 6.964% and that of the median showed to be slightly higher as 5.504%. The average of ROOA was 2.8 times bigger than that of the ROE but the median was 5.504% which was similar to ROE s 5.560%. This shows that the results of operating activities of companies played the role of enhancing ROE. 10

11 The mean of ROIA showed to be % which was higher than the ROOA (6.964%) and ROE (2.468%). The median (6.579%) was also higher than that of ROOA (5.504%) and ROE (5.560%). Moreover, the minimum value of ROIA was 0.031%, not a negative value. These results show that the investment performances were better than the operating performances. The mean of debt ratio was % and the median was %. This means that in general, a company s debt was not much of a burden as being about 45% of the owner s equity. However, the minimum value of the debt ratio was 6.126% and the maximum %, which was more than twice of the owner s equity. These imply that the amount of debt percentage varies enormously between companies. Table 2: Descriptive Statistics of Variables Variables Mean Standard Deviation Min Median Max Par Price ROE ROOA ROIA ,957.7 Debt Ratio Ln_Size All the variables were winsorized by 1% both upper and lower Par Price : Per share price at the end of financial statements disclosure month divided by par value ROE : Return of equity ROOA : Return on operating assets ROIA : Return on invested assets Debt Ratio : Total debt divided by total capital Ln_Size : Ln(total assets) 4.2 The Correlations among Variables The correlation coefficients among variables are presented in [Table 3]. Pearson correlation coefficients are presented in the lower parts of diagonal, and Spearman rank correlation coefficients are presented in the upper part of diagonal. All the Pearson correlation coefficients were statistically significant at 5% level except for the coefficient between ROE and ROIA. And all the Spearman rank correlation coefficients were statistically significant at the 5% level without any exception. These results show that the relationship between variables were closed connected. ROE, ROOA, and Size showed positive relationships with Price. And ROIA and Debt ratio showed negative relationships with Price. This means that the stock prices of the companies with higher operating performances were high, but the companies with lower operating performances were related to lower stock prices. The debt ratio was related to low stock prices because more debt was regarded as more risks. 11

12 ROE and ROOA showed positive relationship with size and negative relationship with debt ratio. In addition, ROE showed significantly positive relationship with ROIA in Spearman lank correlation. This shows that ROE was high in results of high sales and investment but low in large debt ratio. This result tells us that the increase of a company s financial leverage did not affect the increase of ROE, but rather the decrease of it. This, in the case of Korea, means that debt financing might not be able to bring out the increase of ROE. The investment performance (ROIA) and financial leverage (debt ratio) showed negative relationship with the operating performance (ROOA). The size showed positive relationships with the stock price, ROE, ROOA, and the debt ratio while being in a negative relationship with the ROIA. Table 3: Correlations among Variables Variables Par Price ROE ROOA ROIA Debt Ratio Ln Size Par Price ROE ROOA ROIA Debt Ratio Ln_Size All the variables were winsorized by 1% both upper and lower Cells are graded if significant level of correlation coefficient is less than 0.05 (α 0.05) Pearson correlation coefficients are presented in the lower part of diagonal, and Spearman rank correlation coefficients are presented in the upper part of diagonal 4.3 The Effect of ROE and ROE Factors on Stock Price Stock prices of all sample companies regressed on the ROE and LN-SIZE, and ROE factors and LN_SIZE. The significance of regression coefficient was tested by White heteroskedasticty constant t statistics. The results of regression analyses are presented in [Table 4]. The coefficients of ROE and LN_SIZE were positive and statistically significant. These mean that ROE as the comprehensive indicator of management performance affected the stock price positively. That is, to increase the stock price, it needs to increase ROE. Besides that, a company s scale also showed to positively affect the stock price. This means that companies in large scales normally had high stock prices. When the stock price regressed on ROE factors, the coefficients of ROOA and ROIA were positive and statistically significant and the coefficient of Debt Ratio was negative and statistically significant. Moreover, the coefficient of LN_SIZE was positive and statistically significant like the ROE analysis. 12

13 This means that among factors of ROE, the factors related to the investment decision of the manager showed positive relationship with the stock price. Meanwhile, it also means that debt financing, which was another factor related to the financing decision of the manager, showed negative relationship with the stock price. Therefore, when the manager efficiently makes use of the financed fund, which leads to enhancing the operating performance and investment performance, the value of the company increase. Meanwhile, financing activities which increase the debt ratio, can become a factor in decreasing the value of the company. R 2 of ROE analysis was 15.5% and that of ROE factors was 20.4%. This results mean that the ROE factors could have more explanatory power on stock price than on the ROE. These results mean that not only ROE but also the factors which were decomposed by new decomposition methods affected on the stock price. Furthermore, ROE factors decomposed by new method might be more useful than ROE in the stock price explanation. Table 4: The Effect of ROE and ROE factors on Stock Price Variables ROE ROE Factors Coefficient t-value Coefficient t-value ROE ROOA ROIA Debt Ratio LN_SIZE F (p value) (0.00) (0.00) R All the variables were winsorized by 1% both upper and lower The significant of regression coefficient was tested by White heteroskedasticty constant t statistics Cells are graded if significant level of t-test is less than 0.05 (α 0.05) 4.4 The Effect of ROE and ROE Factors on Stock Price According to the ROOA Level For the analyses of the effect of ROE and ROE factors on stock price according to the ROOA level, the samples were grouped into 3 even deciles according to the ROOA for each year. For example, all of the samples of year 2001 were grouped into 3 even deciles according to the ascending order of ROOA. The effects of ROE and ROE factors on stock price were analyzed for each group. In the analyses, size was used as a controlling variable. The significant of regression coefficient was tested by White heteroskedasticty constant t statistics. The results of regression analyses are presented in [Table 5]. In the ROE analyses, unlike the above results of all samples, the effects of ROE on the stock price varied depending on the level of ROOA. ROE was statistically significant positive effects on stock prices in the all sample analyses. However, the coefficient of ROE was 13

14 significant only in the lower level of ROOA. Though the coefficients were positive in all three groups, the coefficients of middle and high levels of ROOA were not significant. The size variable was significant in all groups. R 2 of low, middle, and high groups were each 8.6%, 13.7%, and 20.9%. Considering the non-significant of ROE coefficient, these increases in R 2 might have come from the size variable. The effects of ROE factors on stock price in subgroups were different from all sample analyses for each factor. While debt ratio showed similar results with cases of all sample analyses, ROIA and ROOA showed different results compared to all sample analyses. The coefficient of debt ratio in each sub group was negative like all sample analyses results. However, though the coefficients of ROOA were statistically significant in all sub groups, the sign of coefficient was different in each group. In all sample analyses, the sign of ROOA was positive, but the coefficients of ROOA were negative in lower level group and positive in both middle and higher level groups. In all sample analyses, the sign of ROIA was positive, but the coefficients of ROIA were positive and significant only in higher level group. The coefficients were not significant in middle and lower level groups. These results meant that the effects of ROE factors on stock price were different according to the ROOA level. These results imply that when analysts evaluate a firm s value by newly developed ROE decomposing factors, they need to consider the ROOA level. Table 5: The Effect of ROE and ROE factors on Stock Price by ROOA Level ROOA Level LOW MIDDLE HIGH Variables ROE ROE Factors Coefficient t-value Coefficient t-value ROE ROOA ROIA Debt Ratio LN_SIZE F (p value) (0.00) 9.39 (0.00) R ROE ROOA ROIA Debt Ratio LN_SIZE F (p value) (0.00) (0.00) R ROE ROOA ROIA

15 Debt Ratio LN_SIZE F (p value) (0.00) (0.00) R All the variables were winsorized by 1% both upper and lower The significant of regression coefficient was tested by White heteroskedasticty constant t statistics Cells are graded if significant level of t-test is less than 0.05 (α 0.05) 5. Conclusions and Recommendations The performances of managers can be evaluated by the results of market strategies and financial market policies. ROE can combine the performances of these two aspects as one figure. So ROE is regarded as a comprehensive measure of a firm s performance because it provides the performance of product market strategies and financial market policies. To measure the overall profitability of firm, ROE is decomposed into ROA as the measure of market strategies performance, and equity multiplier as the measure of financial market polices performance. Plus, the ROA is also decomposed as return on sales and assets turnover. However, this traditional approach has some limitations. Therefore, new approaches are on the rise. In one of them, ROE is decomposed as return on business assets and financial leverage effects. The return on business assets is further decomposed as return on operating assets (ROOA) and return on investment assets (ROIA), and financial leverage is decomposed as spread and financial leverage. The purposes of this study were to investigate the effects of ROE decomposition factors that were decomposed by the new approach on the common stock price of the firms listed in Korea s KOSPI market. First, this study reviewed the effects of ROOA, ROIA, and debt ratio on the firm s stock price for the all sampled companies. Second, this study analyzed whether or not the stock price effects of ROE and ROE decomposed factors were influenced by the ROOA level. 5,939 manufacturing companies were sampled out from the Korean KOSPI stock market list in between 2001 and Regression methods were used for analyzing the effects of ROE and ROE factors on stock price. When analyzing the effects of ROE and ROE factors on stock price according to the ROOA level, the samples were grouped 3 even deciles according to the ROOA for each year. The effects of ROE and ROE factors on stock price were analyzed for each group. The results of this study were as follow. First, while stock price showed a positive relationship with ROE, ROOA and Size, it showed negative relationship with ROIA and debt ratio. Second, in the case of analyzing all sample companies, ROE showed positive effects to the stock price, but in cases of analyzing according to the level of ROOA, ROE showed positive 15

16 significant effects to the stock price in groups with lower ROOA levels, while not significant in middle and higher ROOA groups. Third, as an ROE factor ROOA showed positive effect on the stock price but the sign of affecting the stock price was different according to the ROOA level. Fourth, debt ratio showed negative effect on stock prices in all cases. Fifth, ROIA showed positive effect on stock prices only in the case of all sample and higher level group of ROOA. Sixth, size showed positive effect on stock price in all cases. These results imply that when analysts evaluate a firm s value by newly developed ROE decomposing factors, they need to consider the ROOA level. References Basu, Sanjoy, 1983, The relationship between Earnings Yield, Market Value and Return for NYSE Common Stocks, Journal of Financial Economics 12, Chung, Hui-Young and Jang Hee Lee, 2012, An Empirical Study on the Stock Price Correlation of ROE under IFRS, The Korea Corporation Management Review 43, De Wet, J.H.v.H and E. De Toit, 2007, Return on : A popular, but flawed measure of corporate financial performance, Department of Financial Management, University of Pretoria. European Central Bank, 2010, Beyond RoE : How to Measure bank performance, European Central Bank. Fama, Eugene and Kenneth French, 1995, Size and Book-to-Market Factors and Returns, Journal of Finance, Heikal, Mohd, Muammar Khaddafi, Ainatul Ummah, 2014, Influence Analysis of Return on Assets (ROA), Return on (ROE), Net Profit Margin (NPM), Debt To Ratio (DER), and current ratio (CR), Against Corporate Profit Growth In Automotive In Indonesia Stock Exchange, International Journal of Academic Research in Business and Social Sciences 12(4), Kijewska, A., 2016, Determinants of the Return on Ratio (ROE) on the Example of Companies from Metallurgy and Mining Sector in Poland, Metalugija 55 (2), Kwon, S., 2002, The study of accounting classification and the predictive content of ROE, Unpublished master s thesis, Graduate school of Kyunghee University. Kwon, Soo Young and Bo Young Moon, 2009, Decomposed Return on, Future Profitability, and Value Relevance over the Firm Life Cycle, Korea Business Review 38(5), Lee, Seulgi, 2016, The characteristics of the Elements of ROE for the designated firms as Issue for Administration in KOSDAQ, Unpublished master s thesis, Graduate school of Gangneung-Wonju National University. Lundholm, Russell and Richard Sloan, 2013, Valuation and Analysis with eval, 3 rd Edition, McGraw-Hill. Mainul Ahsan, A.F.M., 2011, Can ROE be used to predict portfolio performance?, unpublished master thesis, Texas Tech University. Palepu, K. G., P.M. Healy, and E. Peek, 2013, Business Analysis and Valuation IFRS Edition, 3ed Edition, Cengage Learning. Park, Changrae, 2017, The Effects of ROOA(Return on Operating Assets) and ROIA(Return on Investment Assets) on the assets structure, unpublished Proceedings of the Eighth European Academic Research Conference on Global Business, Economics, Finance and Social Sciences. Penman, Stephen H., 1991, An Evaluation of Accounting Rate of Return, Journal of Accounting, Auditing, and Finance, Penman, Stephen H., 2010, Financial Statement Analysis and Security Valuation, 4 th Edition, McGraw- Hill. 16