Combined MCDM techniques for exploring stock selection based on Gordon model
Introduction
The Gordon model1 proposed by Gordon (1962) noted that price change is affected by predicted dividend, discount rate, and dividend growth rate. Coupled with the model’s ability to predict future dividend discount and assess a reasonable level of stock price, it is widely received and applied. In fact, however, investors care about what types of stocks are worth investing. This is to say that they are interested in determining what factors influence Gordon model’s three fixed variables, and the level of importance of each individual factor. The Gordon model only explained that three important factors impact stock prices but a description of more detailed factors was not available. Therefore, through extensive literature review, this study identified the factors that were to be influential of projected dividend, discount rate, and dividend growth rate, and examined the level of importance of these factors in an effort to make up for the inadequacy of the Gordon model.
Previous studies on stock price were mostly focused on exploring the relationship between stock price and macroeconomic factors such as currency supply (Dayananda and Ko, 1996, Gargett, 1978, Homa and Jaffee, 1971, Mookerjee and Yu, 1997, Robichek and Cohn, 1974, Rada, 2008), inflating rate (Chen et al., 1986, Fama, 1981, Gultekin, 1983, Lee, 1992, Ross, 1989), and interest rate (Cochrane, 1991, Dayananda and Ko, 1996, Domain et al., 1996, Nedović and Devedžić, 2002, Quah and Srinivasan, 1999, Spiro, 1990). Also, since these studies were conducted on unidirectional relationships, the research results were not consistent. For investors, the message conveyed was simply what factors influence stock price and whether the influence was positive or negative. Therefore, these findings contribute little to the goal of constructing a complete set of stock selection model, and especially a comprehensive analysis of factors and interactive relationships. Meanwhile, researches on the relative weight among variables were also scant.
Therefore, the purpose of this study is to supplement the Gordon model and that of previous findings on stock price in establishing an investment decision model by experts to provide investors with a reference/selection of stocks most suitable for investing effects to achieve the greatest returns. This research utilized MCDM and adopted the Gordon model. Through literature review, we identified the sub-factors of predicted dividend, discount rate, and dividend growth rate in order to construct the investment decision model. In addition, through a survey of experts, we determined the level of importance and weights of factors affecting stock selection. By doing so, we can gain a clear understanding of the important factors influencing stock selection. The relative weights of each factor were then used to examine and decide on the investment criteria. Since the factors of the Gordon models were interrelated, this study introduced the ANP to express investors’ level of importance and measured the relative importance of variables. Subsequently, we ranked the data to identify the key factors. Evaluation targets were taken from leadership companies of the hottest stocks in the electronics sectors: lens, solar, and handset. We then identified the most suitable investment and offered a full description and testing of the decision model for investors’ reference.
The rest of this paper is organized as follows: in Section 2, we identify the sub-factors influencing predicted dividend, discount rate, and dividend growth rate in order to establish the evaluation criterion on stock evaluation model based on literature review. In Section 3 the description and application of ANP are contained. In Section 4, we used ANP to calculate and analyze the relative weights of each criterion and the related stock. Finally the conclusions and remarks are presented in Section 5.
Section snippets
Stock price evaluation model
The purpose of this section is to identify the influential factors of stock price according to past literatures and discuss the areas of inadequacies in these studies. To compensate for such a gap, this study conducted a literature review of Gordon model’s three main factors – predicted dividend, discount rate, and dividend growth rate – in order to more accurately identify the evaluation criteria affecting stock price.
Building the MCDM model for stock selection
This section adopts the Gordon model as the research framework and determines the criteria of stock evaluation and selection through literature review. The investment decision model is then established by experts. Because various dimensions of the investment model were interrelated, this study uses MCDM model’s ANP to discuss and analyze each criterion for stock evaluation and selection.
Empirical case – using electronics stocks as an example
This section mainly discussed the factors that financial scholars, stock investment experts and mutual fund managers’ consider important when making stock selections. Also, ANP was used to present each expert’s level of importance and measure the relative importance among factors/dimension and criteria. Further, the critical factors in making stock selections were made and lens, solar and handset stocks were used as the selection targets to illustrate and test the investment decision model of
Conclusions and remarks
The Gordon model is widely used by financial textbooks as an important reference in evaluating stocks. Mathematical models have indicated that predicted dividend, discount rate, and dividend growth rate are influential of stock prices. However, the sub-factors influencing these three factors are uncertain and they are not explained in mathematical models. These three factors’ level of importance to stock prices is also not mentioned, although an understanding of the importance of these factors
References (42)
Shareholder wealth, information signaling and the specially designated dividend: An empirical study
Journal of Financial Economics
(1983)Risk and return: CAPM and CCAPM
The Quarterly Review of Economics and Finance
(2003)Dividend changes and earnings performance in Japan
Pacific-Basin Finance Journal
(2000)- et al.
Macroeconomic variables and stock prices in a small open economy: The case of Singapore
Pacific-Basin Finance Journal
(1997) - et al.
Expert systems in finance – a cross-section of the field
Expert Systems with Applications
(2002) - et al.
Improving returns on stock investment through neural network selection
Expert Systems with Applications
(1999) Expert systems and evolutionary computing for financial investing: A review
Expert systems with applications
(2008)- et al.
Selecting knowledge management strategies by using the analytic network process
Expert Systems with Applications
(2007) - et al.
A survey of management views on dividend policy
Financial Management
(1985) - et al.
Do firms use dividends to signal large future cash flow increase
Financial Management
(1998)