Factors influencing selection of stocks (Stock Investing) - The Thesis

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Factors influencing selection of stocks (Stock Investing)


Stock Chart and spectacles
This article was formally titled "3 Secrets to Stock Investing"

Introduction
Factors influencing selection of stocks (Stock Investing can be grouped into three. As the pace of development in Africa continue to pick up speed, access to more capital has become paramount. This has partly led to the emergence of several stock exchanges on the continent. Prior to 1989, there were only six (6) stock exchanges in Africa. However, as at 2010 there were 19 African stock exchanges (Agyemang, 2010). To all intents and purposes, stock exchanges are created as a way of providing a platform for listed businesses to raise capital from investors, in return for part ownership in the listed entity. Investors make money from their invested capital either through dividends or capital gains.  The securities traded may be in the form of shares, bonds and the like.


Stock investing or selection of stocks is a function of both subjective and objective variables (Virlics, 2013). Making decisions as to which stock to select does not come easy to investors (Kengatharan & Kengatharan, 2014), possibly due to risk reward considerations.

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Stock investing driven by investor decisions is very important in that it shapes how the market trends, which in turn influences the health of a country's economy (Kengatharan & Kengatharan, 2014). After all, the stocks represent businesses and the business employs the citizens of the country and so if a stock is doing well because investors have chosen to purchase it, it would impact on the economy positively. According to Kengatharan & Kengatharan (2014), “the stock market constitutes a gauge of the health of a nation’s economy. In this sense, a gauge of Ghana’s economic health is its stock exchange, the Ghana Stock Exchange (GSE).

There are a myriad of factors that influence selection of stocks by investors. It has to be said that the factors which determine stock investing amongst investors are likely to vary from country to country and from stock exchanges to stock exchanges. This may be possibly because of the heterogeneity of investors (Gunathilaka, 2014) as well as the environment. A working knowledge of these stock investing factors is the secret to stock investing. For example, whilst dividend payout is significantly important to investors on the Nairobi Stock Exchange in decision making, it is not, as far as investors on the Colombo Stock Exchange, Sri Lanka, are concerned (Gunathilaka, 2014; Agongo & Mutswenje, 2014). For the purpose of this discourse, stock investing factors shall be broadly grouped into three: behavioral, demographic, macroeconomic/political factors (Barberis and Thaler, 2003; Kengatharan & Kengatharan, 2014; Ritter, 2003).

Behavioral factors
Traditionally, it is thought that investors are rational and so would naturally make rational decisions conforming stock investing decisions to “basic financial rules based on their investment strategies and risk-return consideration” (Dunusinghe & Ranasinghe, 2015: 1) as per the views of traditional finance theories such as Capital Asset Pricing Model (CAPM), Efficient Market Hypothesis (EMH), and Modern Portfolio theories. However, a number of studies indicate that the behaviour of market participants and their psychology at any point in time may influence their decision to either select a stock or not (Hodge, 2003). For example, optimistic behaviours in investors tend to cause over reactions in the market, making prices of stocks rise beyond what can be justified by a firm’s fundamental. The reverse holds true for pessimistic behaviours.

Kengatharan & Kengatharan (2014) propose that there are four subcategories under behavioral factors: Herding, Heuristics, Prospect and Market factors. Prospect occurs when an investor makes a subjective decision on the basis of his own value system; herding effect in finance is seen as the propensity of investors’ to buy or sell a stock on the basis of what others are doing. In a complex and uncertain environment like the stock market, certain guidelines can be put together to form the basis for easier decision making on stock investing or stock trading or to serve as a tool for predicting market trend (Kahneman & Tversky, 1974; Ritter, 2003). These guidelines or “rules of thumb” constitute heuristics. The table below provides insight into variables that make up each sub-factor:

Table 1: Behavioral factors influencing Stock Investing (Stock Trading)
Behavioral Sub-factors
Behavioral variables
Heuristics
Representativeness, overconfidence, anchoring, gambler's fallacy, availability bias
Prospect
Loss aversion, regret aversion, mental accounting
Market
Price changes, market information, past trends of stocks, fundamentals of underlying stocks, customer preference, over-reaction to price changes
Herding Effect
Buying and selling decisions of other investors, choice of stock to trade of other investors, volume of stock to trade of other investors, speed of herding
Source: Waweru et al. (2008)


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Every investment comes with some level of risk (Francis, 1991). Investors react differently to risks; a level of risk tolerable to one investor may be intolerable to another (Cheney and Moses, 1999). This risk level may make investors behave irrational at times. Investor risk aversion may either come in the form of loss aversion or regret aversion as shown in Table 1.

Kengatharan and Kengatharan (2014) in their study found that herding, heuristics, prospect and market sub factors respectively accounted for 15.2 %, 13.3 %, 7.8 % and 6.0 % of stock investing decisions by investors. From their results, it appears that behavioural influence on investors towards stock investing is most accounted for by the herding dimension, followed by heuristics. Not all the behavioral variables in Table 1 were found to be significant. For instance, of all the behavioral variables for heuristics only overconfidence and anchoring was found to be significant. Overconfidence was found to have a negative significant impact on investment performance, whereas anchoring registered a positive significant impact on investment performance.

In another study, it was observed that how investors perceived the worth of the firm was found to be the most important factor in influencing selection of stock in Colombo Stock Exchange (CSE), Sri Lanka (Gunathilaka, 2014). Other selection factors found to be of import on the same exchange were risk, historical prices and accounting information.


Jagongo & Mutswenje (2014) working on factors that influence stock investing or stock trading by investors on the Nairobi stock exchange observed some of the most important factors to be: reputation of the firm, firm’s status in industry, expected corporate earnings, past performance of firm's stock, price per share, sentiment on the economy and expected dividends.
Macroeconomic/ Political Factors
Macroeconomic factors such as high interest, inflation and exchange rates play vital roles in how listed companies on the stock market perform and consequently on investor decisions to select stocks. This is because: (1) high interest rates mean high cost of borrowing for businesses, which may make them borrow less than they actually need or use a chunk of their profits to pay the interests on the loans collected; (2) high inflation rates imply a reduction in the purchasing power of available funds or borrowed funds by listed businesses; whereas (3) high exchange rates mean listed companies will spend more money to import the same or less amount of inputs for their operations.

Working together, these macroeconomic considerations may result in a firm performing well below investor expectations, thus leading to a firm’s unattractiveness and that of the entire stock exchange as a whole. A case in point was when in 1995 when the GSE recorded a dreadful growth rate of only 6.3 % (Baah, 2011). According to Baah (2011), the poor performance by the bourse was attributable to high interest, exchange and inflation rates.

Furthermore, findings from a study by Aizenman and Marion (1995) found that macroeconomic variables (terms of trade, inflation, real exchange rate) negatively correlated with investment by investors. This means that as macroeconomic variables such as inflation and real exchange rate increases, investment or stock trading diminishes.

Political factors such as General Elections, tax increments, adherence to democratic principles and foreign political news may influence an investor’s decision to purchase or not to purchase a stock. For example, in Iran, political factors are given the most consideration before stocks are selected (Yahyazadehfar, Zali, & Shababi, 2011). They report that on the Tehran Stock Exchange, political factors accounted for 79 % of stock trading decisions by investors; whilst, economic factors accounted for 47 % of the variation in investor decision.

Demographic Factors
Demographic factors such as age, gender, marital status and income and educational levels may significantly influence investor stock investing (Hossain & Nasrin, 2012). Age and gender are probably amongst the most common demographic factors that may directly or indirectly influence stock selection. According to Bashir et al. (2013),  age and gender affect investment behaviours which in turn affect stock trading decisions (Bashir et al., 2013). Younger people are more likely to take greater risks than older people and also men tend to take more risks in stock investing or stock trading than females. According to Barber and Odean (2001), males invest more than females; also, males invest more aggressively than females. Investigating whether stock selection factors significantly differed between males and females, Hossain & Nasrin (2012) found that it does.

Conclusion
In conclusion, different factors come into play to influence selection of stocks and these factors may be behavioral, macroeconomic and or even demographic. Which factor or factors affect your investing (stock trading) decisions?

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References
Agyemang, C. A. (2010). How the Ghana Stock Exchange can be improved. Ashesis University College.

Baah, E. (2011). Shareholding Structure And Financial Performance Of Listed Companies In Ghana. Kwame Nkrumah University of Science and Technology.

Bashir, T., Scholar, M., AaqibaJaved, M., NazishAzam, S. A. A. B. S., Tanveer, A., & IrtazaAnsar, M. S. (2013). An Assessment Study on the Factors Influencing the Individual Investor Decision Making Behavior”. Journal of Business and Management, 9(5), 37–44.

Dunusinghe, L. M. C. S. M. P., & Ranasinghe, A. (2015). Behavioural Factors Influence on Investment Performance: A Survey of Individual Investors at Colombo Stock Exchange. In Proceedings of 10th Annual London Business Research Conference (pp. 1–17). London, UK.

Gunathilaka, C. (2014). Factors Influencing Stock Selection Decision: The Case Of Retail Investors In Colombo Stock Exchange. In 11th International Conference on Business Management (pp. 107–115).

Hossain, F., & Nasrin, S. (2012). Factors Affecting Selection of Equity Shares : The Case of Retail Investors in Bangladesh. European Journal of Business and Management, 4(20), 110–125.

Jagongo, A., & Mutswenje, V. S. (2014). A Survey of the Factors Influencing Investment Decisions : The Case of Individual Investors at NSE. International Journal of Humanities and Social Science, 4(4), 92–102.

Kengatharan, L., & Kengatharan, N. (2014). The Influence of Behavioral Factors in Making Investment Decisions and Performance: Study on Investors of Colombo Stock Exchange, Sri Lanka. Asian Journal of Finance & Accounting, 6(1), 1. doi:10.5296/ajfa.v6i1.4893

Virlics, A. (2013). Investment Decision Making and Risk. Procedia Economics and Finance, 6, 169–177. doi:10.1016/S2212-5671(13)00129-9


Yahyazadehfar, M., Zali, M. R., & Shababi, H. (2011). Determinants of investors’ financial behaviour in Tehran Stock Exchange. Applied Economics Letters, 18(7), 647–654. doi:Pii 932370850\rDoi 10.1080/13504851003781416

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