Small Firm Effect Anomaly in Nepalese Stock Market - Analysis

Introduction

Investing in financial securities like stocks, bonds, certificates of deposits, marketable securities etc. has rapidly increased in recent years. With growing investments, investors are concerned about the performance of the companies they opt to invest and are searching for ways to increase value of their portfolio. Various factors play important role in earning higher return in investment. One of the important factor is market capitalization. According to behavioral finance small cap companies earn higher average return than large cap companies.

Market Capitalization

Market capitalization refers to the value of all the outstanding shares of the corporation. It is calculated by multiplying the number of a company’s shares outstanding by its stock price per share. It represents the market estimate of the “value” of the company. Though market capitalization does not provide information about the size of the company in terms of assets or revenue, it provides information about the company’s market depth. On the basis of market capitalization stocks are categorized into three categories in general; small cap, mid cap and large cap. A large cap company has a market capitalization over $10 billion. Investment in these companies does not necessarily bring in huge returns in short period of time, however, in the long run, these companies reward investors with consistent increase in share value and dividend payments. A mid cap company has market capitalization between $2 billion and $10 billion, and operate in an industry expected to experience rapid growth. Finally, a small-cap company has less than $2 billion in market capitalization. They are most likely to be young in age and/or serve the niche markets and new industries. Thus, they are also considered higher risk investments.

Analysis

The market capitalization of sample companies are given below:

Large Cap Stocks

The table represents the top 30% large cap stock among the sample of 50 stocks representing NEPSE index. We can see that most of the large market capitalization stocks represents stocks of commercial bank with 8 among the 13 stocks representing commercial banks. The average return of top 30% high cap stock is 0.1178%.

Small Cap Stock

The above table represents top 30% low cap stock among the sample of 50 stocks representing the NEPSE Index. We can see that the majority of low cap stocks represents Development banks and Microfinance with 7 development bank and 6 microfinance companies. The average return of Small cap companies is about 0.2210%.

The findings shows that the companies which has small market capitalization earns higher return than the companies which has high market capitalization. When we analyze the daily return of 50 NEPSE companies for five year time period we find that the average daily return of small cap stock is 0.2210% which is higher than the average daily return of large cap stock i.e. 0.1178%. This finding is consistent with findings of research conducted in international market. Various reasons have been pointed out for this anomaly.

Conclusion

After analyzing 50 samples our findings shows that the companies which has small market capitalization earns higher return than the companies which has high market capitalization. This shows the presence of small firm effect anomaly in Nepalese market. In almost all of the stock market, there exists negative relationship between stock returns and market value of common equity of the firm. The findings are also applicable in Nepal. In both developed and developing stock markets, small firms outperform the large firms but however some of the studies also indicate that this tendency tend to fluctuate over time.

- Pratikshya Ghimire, Manisha Joshi, Manjil Dulal, Rabin K. Bhatt, Shrijana Bhattarai