Are changing margins factored into stock prices?

Abstract

Stocks returns are often associated with the value of the company. There are many ways in which research has found viable variables to predict the future stock return, including autocorrelation of the stock prices, using the P/E ratio or more recently using the GP/A ratio. Having clear evidence that the GP/A ratio is useful to predict future stock return, this paper asks whether margin, which is GP/net sales, if changed, is factored into stock prices. Qualitatively, a common hypothesis is that when a company improves its profit margin, the company becomes more profitable and increases its returns. In this paper, I verified the hypothesis quantitatively.

In this paper, I explored three types of studies to verify the hypothesis. The three studies are 1) a correlational study, 2) a portfolio study, and 3) a regression study. From the above studies, I found out that there is a significant linear relationship between changing a margin and stock returns, the margin change is directly proportional to both current price difference and forward price difference, and finally the margin change variable is significant irrespective of the industry and the specific year the company is in.