Correlation between commercial banks and NEPSE index; what implication does it have in your investment decision?

Fri, Feb 15, 2019 12:19 PM on Company Analysis, Exclusive, Stock Market,

Correlation is defined as the statistical association or relationship between variable under consideration. It basically shows how close the variables are to having a linear relationship.

In stock market, this correlation often plays a significant role. There are interest-sensitive stocks, cyclical stocks and deep-cyclical stocks that moves in tandem with the market index or opposite to the market index. The stock market index, supposedly is a portrayal of the overall performance in the economy. So based on the nature of business and operation, some companies go up when index goes up and others have an inverse relationship.

If we look closely, the bull of 2016 was led by the BFIs index i.e. these sectors gained the highest points during that period. In similar manner, we can also access the correlation between the NEPSE index and the individual company's share price to see if there is a relation.

Going into the commercial banking sector, there are currently 27 listed banks in NEPSE. In order to find the correlation coefficient between the company's share and price and the NEPSE index, we have taken the data of one year (from 2018 Feb 11 to 2019 Feb 11). The findings is shown as:

The banks with positive correlation coefficient shows that when the index goes up, the bank's share price also goes up and the opposite is true for negative values. Similarly, the higher values indicate a stronger relationship between the index movement and the share price movement.

As you can see only PRVU and NICA have negative correlation coefficient. PRVU’s prices have been rising even though the market is bear and this can be attributed to its good performance which has attracted investors. And when the demand is high, the prices also rise.

Similarly, in case of NICA, the bank is adopting an aggressive mode of growth. This can be seen through their competent interest rates, rapid expansion of branches and so on. This also has led the banks’ prices to rise.

So next time you are considering investing, the correlation coefficient can be an indicator to look at. If the market is bull, shares with positive coefficient are the ones to pursue and vice versa. However, we’d also like to add a caveat that the correlation coefficient can’t be taken as full basis for your investing decision. You will also have to look at the companies’ fundamentals, technical trends and economic indicators.