INTRODUCTION
Problem Statement
Financial integration has provided advantages for both source and host countries, particularly in increasing investment This process facilitates capital flows from wealthier nations to developing countries, enhancing economic growth and development in these host nations.
To mitigate risks in foreign investments and address the frequent crises in the global economy, many hedge funds have been established to adapt to these trends In fact, the influx of portfolio investments and foreign hedge funds has been cited as a contributing factor to the crisis.
This study explores the connection between foreign investors' investment decisions and the Vietnamese stock market, focusing on the trading volume of stocks that are heavily favored by foreign investors By analyzing these trends, the paper aims to equip both domestic and international investors with valuable insights into the types of companies that attract foreign buying or selling decisions, as well as their long-term ownership ratios.
Research questions
The final purpose of this paper is to answer the following questions:
(i) Do foreign investor’s buying and selling decisions really focus on stocks of large companies with better profitability?
(ii) How do their buying and selling volume affect to their ownership ratio?
Research objectives
This paper aims to assess how various firm characteristics influence foreign investors' decisions regarding buying and selling, as well as their long-term ownership ratios Additionally, it will provide a detailed analysis of these factors across different industries.
Economic theories
Foreign capital primarily enters developing and emerging countries through three main channels: foreign direct investment (FDI), portfolio investment, and foreign debt FDI can occur via Greenfield projects or mergers and acquisitions, both of which have seen substantial growth in emerging markets, as noted in the World Economic and Social Survey 2005 Conversely, portfolio investment encompasses various financial instruments, including equity securities, bonds, money market instruments, and financial derivatives.
Investors in country A could invest in country B or vice versa to seek for diversification in their portfolios in term of risk (balancing their portfolios) and expected (equity) return
(b) Foreign investment in relation to stock market
Foreign Direct Investment (FDI) has been shown to significantly enhance domestic stock market development, as evidenced by various empirical studies (Adam and Tweneboah) FDI complements stock market growth, demonstrating a positive correlation with market capitalization and domestic value traded (Claessens et al., 2001) Additionally, with increased global financial market integration, foreign portfolio investment has risen, offering advantages such as high mobility and the ability to mitigate existing constraints in the bond markets of developing and emerging economies.
Foreign investors consistently search for lucrative investment opportunities, shifting capital from firms with limited prospects to those with greater potential However, the average returns on various investor portfolios can vary significantly, as some investors prioritize ownership of stocks or companies for specific goals, such as fostering business relationships and exercising control, rather than solely maximizing financial returns (Kim et al., 2005).
Analyzing firm characteristics through financial metrics primarily involves ratio analysis, which can be categorized into several key groups: market value measures, profitability measures, short-term solvency or liquidity measures, long-term solvency measures, and asset management or turnover measures, as noted by Ross et al (2005; 2010).
This paper primarily examines four key financial metrics: market value, liquidity, profitability, and long-term solvency Additionally, it considers the impact of dividend policy on a firm's capacity for sustained growth, as outlined by Ross et al (2005; 2010).
2.1.2 Relationship between foreign investor and firm characteristics
Foreign Direct Investment (FDI) flows are significantly influenced by stock evaluation components that indicate mispricing, particularly in environments with capital account restrictions that hinder portfolio investors' arbitrage opportunities (Baker et al., 2009) This highlights the critical relationship between foreign investors and market value measures.
Market capitalization significantly influences stock returns for foreign investors, who tend to favor large-cap firms This preference stems from the need for liquidity and redemption, as well as a desire to mitigate systematic risk associated with their investments.
Research indicates that foreign investors generally favor firms with large market capitalization and robust financial performance (Kang and Stulz, 1997; Lin and Shiu, 2001; Kim et al., 2005) However, contrasting findings suggest that smaller firms often yield higher stock returns compared to their larger counterparts (Banz, 1981; Keim, 1983; Basu, 1983).
Research on price-to-book (PB) and price-to-earnings (PE) ratios reveals mixed findings regarding their relationship with stock returns Some studies indicate a negative correlation between PB ratios and stock returns, suggesting that foreign investors can achieve higher returns by purchasing low PB stocks Conversely, other research shows that foreign investors tend to favor stocks with high PB ratios This divergence in findings highlights the complexity of investor preferences and strategies in the stock market.
In regard to PE ratio, this is considered to be the single most important variable in determining a share’s price As a matter of fact, Basu (1977), Breen (1978) and Dreman
Research indicates that stocks with low price-to-earnings (PE) ratios typically yield higher average returns compared to those with high PE ratios However, recent empirical studies reveal that foreign investors are inclined to purchase stocks that have outperformed the market and sell those that have underperformed This highlights the complex relationship between foreign investors and profitability measures in the stock market.
Research indicates a significant positive correlation between foreign ownership and the Return on Equity (ROE) ratio, highlighting its importance for foreign investors (Kim et al., 2005) Bae et al (2011) further confirmed that foreign investors tend to favor stocks of Korean companies with high ROE and Return on Assets (ROA) ratios, as their "buy" stocks consistently outperform their "sell" stocks in terms of profitability over both the current and subsequent periods Additionally, a study by Kang et al (2010) on firms listed on the Korean Stock Exchange revealed that corporate profitability, as measured by EBITDA, is also positively associated with foreign ownership.
According to Kang et al.(2010), liquidity ratio has positively correlated with foreign ownership into Korean Stock Exchange listed companies However, Vo Xuan Vinh
(2010) found that liquidity ratio has negatively correlated with foreign ownership for firms listed on Ho Chi Minh Stock Exchange
Foreign investors tend to adopt a buy-and-hold strategy for their long-term investments rather than focusing on short-term gains Additionally, there is a notable relationship between foreign investors and the financial leverage ratio, indicating their strategic approach to investment.
Many empirical studies revealed that foreign investors favor firms with low debt ratio (Kang and Stulz, 1997; Lin and Shiu,2001; Kang et al.,2010 and Vo Xuan Vinh,
Foreign investors tend to favor companies with low leverage ratios; however, studies by Bae et al (2011) and Mishra and Ratti (2011) indicate that firm leverage does not significantly influence foreign investors' decisions to buy or sell Additionally, the relationship between foreign investors and dividend policy remains an important area of study.
Besides preferring large-size firms , foreign investors were found to prefer stocks with high dividend yield (Jeon et al., 2010; Mishra and Ratti, 2011 and Bae et al.,2011)
Meanwhile, Dahlquist and Robertsson (2001) found that foreign investors also prefer stocks of lower paid-dividend firms.
Related empirical studies
Table 2.1: Summary of related empirical studies as following table:
Panel data with random effect model
They prefer large firms with high PB ratio, low dividend yield
2001) Stock.E foreign and institutional ownership
Firm size, PB ratio, ROE, average return
Fama–French three-factor mode
F.ownership positively correlated with firm size,
Daily purchase, and total value of foreigners
PE,PC,MKC, Price, ownership data
A standard linear model, Panel data with pooled model
Their buying, selling and net purchase have a positive relationship with firm size and negative relationship with PE ratio
A standard linear model, Panel data with Pooled model
Foreigners prefer large firms, firms with low PB, or low leverage ratio
Buying and selling among groups of investors
PE, PB, Dividend, CF⁄ Sales three reference pricing models
They buy stocks with higher ROE and ROA than their selling, prefer stocks of large firms and high dividend yield.
Conceptual framework
All expected relationships among variables could be likely summarized as the following tables:
Table 2.2: Summary of expected signs:
Expected signs Buy volume Sell volume Ownership ratio
SELLING AND BUYING VOLUME Net purchase
Research context
Since its establishment in 2000 for the Ho Chi Minh Stock Exchange (HSX) and 2005 for the Hanoi Stock Exchange (HNX), the stock market has played a crucial role in mobilizing capital for the economy, demonstrating significant and essential contributions reflected in its annual percentage of total volume relative to GDP.
Table 3.1: Viet Nam Market capitalization
Vietnam stock Market capitalization (%GDP)
% GDP Market capitalization of listed companies (current US$ mil.)
Source: Word Bank – Global Financial Data
Source of Data and its definition
Firstly, the research will select data from 2007 to 2011 just because only from 2006 onward the total volume trading by foreign investors has significantly increased
The study will examine listed stocks from three key industries on HSX and HNX: Construction and Real Estate, Manufacturing, and Finance and Insurance These stocks, listed prior to 2007, must have a market capitalization exceeding VND 100 billion as of July 13, 2012, and will include data on foreign trading activities The analysis will encompass over 98 firms, resulting in more than 420 observations over a five-year period.
Table 3.2: the structure of industry in dataset(as of July 13, 2012)
Source: Author’s calculate on the data set
(i) Market Capitalization (MKC): this variable is the market capitalization of each firm at the year-end
(ii) Dividend paid (DIV): how much dividend actually paid to each shareholder
The Price Book (PB) ratio is a financial metric that compares a company's book value to its market value This ratio helps investors assess how the market values a firm in relation to its actual worth, calculated by dividing the market value by the book value.
(iv) Price Earning ratio (PE): a share price divided by earning per share
(v) Return on Equity (ROE): Net income divided by the book value of equity at year end
(vi) Return on Asset (ROA): An indicator to measure how profitable a company is generated from the invested capital (assets)
Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a key financial metric that helps assess and compare the profitability of different companies by removing the impact of financing and accounting choices.
The ownership rate (OWN) indicates the percentage of shares held by foreign investors, with Foreign Investment Laws stipulating that foreign ownership in a company cannot exceed 49% This limitation significantly influences foreign investors' trading decisions.
(ix) Debt to Equity Ratio.(DEBT): defined by total liabilities divided total equity often at year end
(x) Current Ratio (C_Ratio): measures a company's ability to pay short-term obligations calculated by current assets divided by current liabilities
(xi) Quick Ratio (Q_Ratio): is calculated as (Current Assets - Inventories) / Current Liabilities
Research Methodology
The estimated equation is a linear regression model as follows:
- YI,t denotes buying, selling and ownership ratio for firm i at trading year t
- XJ, I, t presents the firm characteristic variables j of firm i at year t which are divided into stock characteristics including MKC, PB, P/E ratio, ROE, ROA, EBITDA , DEBT , C_Ratio, Q_Ratio or Dividend Yield
- αi are random individual-specific effects, β is a vector of our robust estimators; and ε is a error term;
This paper utilizes panel data, which offers distinct advantages compared to pooled data To determine the most suitable models for the specified samples, it will evaluate various regression models, including the Fixed-Effects Model (Least Squares Dummy Variable Model), the Random-Effects Model (Random Intercept, Partial Pooling Model), and the Pooled Model (population-averaged model).
After finalizing the appropriate model, to control for heteroskedasticity the option
The article will utilize a robust regression approach to analyze the data Additionally, to identify potential multicollinearity among the variables, the variance inflation factor will be applied following the regression model Detailed test results will be available in the appendix of the paper.
CHAPTER 4: DATA ANALYSIS AND DISCUSSION
Descriptive Data Analysis
Table 4.1: Description of variables of the whole sampled stocks: buy sell net_buy own MKC DIV EBITDA
Source: Author’s calculate on the data set with Stata software
The finance industry boasts the highest market capitalization, while the construction and manufacturing sectors rank second and third, respectively Notably, construction stocks hold the highest average price-to-earnings ratio at 25 times, with finance and manufacturing stocks following at 15 and 11 times.
The foreign ownership ratio across surveyed firms in the finance and manufacturing industries stands at 20%, while the construction industry shows a slightly lower ratio of 17% Notably, the construction sector exhibits a significantly high average debt ratio of 2.35 times, compared to the manufacturing and finance industries, which have debt ratios of 1.33 and 0.66 times, respectively.
Table 4.1: Description of variables of the whole sampled stocks (continued):
PE PB ROE ROA C_Ratio Q_Ratio Debt
Source: Author’s calculate on the data set with Stata software
Table 4.2: The summary of volume and value traded of the whole sample
Source: Author’s calculate on the data set with Stata software
In 2010, Vietnam experienced a significant net inflow of portfolio equity, which represented 2.24% of the country's GDP During this year, the average price-to-earnings (PE) ratio across the entire sample was notably low at 10 times, indicating that stocks were relatively undervalued.
2010 were cheapest during five years.
Table 4.3: Percentage of FDI and Portfolio inflows over GDP in Viet Nam
Foreign direct investment, net inflows
Portfolio equity, net inflows (% of GDP) 8.79% -0.63% 0.13% 2.24% 0.86%
Source: World Bank - Global Financial Data
The Vietnam stock market, often regarded as undervalued, continues to attract significant foreign capital inflows, particularly in the realm of portfolio equity investments Analyzing the average statistics of key variables over the past five years provides valuable insights into their potential trends.
Table 4.4: the summary of statistics by mean of each industry:
Source: Author’s calculate on the data set with Stata software
The correlation matrix indicates that, aside from the strong correlation between ROE and ROA, as well as between the Quick and Current ratios, the remaining variable correlations are relatively low Therefore, the regression model will address multicollinearity among these variables.
Empirical Results
(a) Firm characteristics and foreign investor’s buying volume:
Table 4.5: The coefficient signs between buy-volume with other independent variables:
Buy volume Whole sample Finance stocks Construction stocks Manufacturing stocks
(*** and ** present statistical significance level at lower 5% and 10%, respectively)
Foreign investors are increasingly favoring value stocks in the finance and construction sectors, particularly those of large firms that demonstrate strong performance and low financial leverage Additionally, there is a noticeable decline in their purchasing volume for companies with high debt ratios across all industries These trends align closely with findings from prior empirical research.
(b) Firm characteristics and foreign investor’s selling volume:
Table 4.6: The coefficient signs between sell-volume with other independent variables:
Sell volume Whole sample Finance stocks Construction stocks Manufacturing stocks
(*** and ** present statistical significance level at lower 5% and 10%, respectively)
The sell-volume variable demonstrates a positive correlation with EBITDA across most industries; however, in the finance sector, it also shows a significant positive relationship with the ROE ratio and a negative correlation with the PB ratio, unlike the manufacturing industry.
Market size is only to affect to foreign investor’s selling decision in finance industry The relationship among other variables is separately differentiated
(c) Firm characteristics and net purchase variable in relation to foreign investor’s ownership ratio
Table 4.7: The coefficient signs between ownership ratio with other independent variables:
Ownership Whole sample Finance stocks Construction stocks Manufacturing stocks
(***and ** present statistical significance level at lower 5% and 10%, respectively)
Analysis of buy and sell volume indicates that foreign investors favor purchasing stocks from large, high-performing companies However, when it comes to maintaining a longer position through ownership ratio, their preference shifts towards firms with low financial leverage, regardless of the company's size.
EBITDA is a crucial factor influencing buying and selling decisions, but it does not impact ownership ratios This financial indicator is particularly significant in the construction industry, where tangible assets are prevalent and subject to one of the three flexible depreciation and amortization methods available to firms.
Table 4.8: The coefficient signs for finance industry:
Finance stocks Buy Volume Sell Volume Ownership ratio
(*** and ** present statistical significance level at lower 5% and 10%, respectively)
Foreign investors tend to favor value stocks of large, highly profitable firms that exhibit low leverage ratios and low dividend yields Their strategy focuses on acquiring and holding these firms over the long term to benefit from high profitability and minimal financial risk Notably, the market capitalization of these firms does not significantly influence the investors' long-term ownership ratios.
Table 4.9: The coefficient signs for construction industry:
Construction stocks Buy volume Sell volume Ownership ratio
(***and ** present statistical significance level at lower 5% and 10%, respectively)
Foreign investors in construction stocks typically seek out large, undervalued firms with low dividend yields and favorable leverage or quick ratios Conversely, they are inclined to sell overvalued stocks or those from companies with high leverage ratios Notably, the size of the firm does not significantly influence their selling decisions.
Investors seeking long-term positions prioritize acquiring firms with strong profitability, as indicated by high EBITDA, low financial leverage ratios, and undervaluation The market size of these firms is not a significant factor in their long-term investment decisions.
Table 4.10: The coefficient signs for manufacturing industry:
Manufacturing stocks Buy volume Sell volume Ownership ratio
(*** and ** present statistical significance level at lower 5% and 10%, respectively)
Foreign investors in manufacturing stocks typically favor high-profitability growth stocks from companies with low financial leverage ratios, while they tend to sell shares of firms exhibiting high quick ratios This behavior aligns with the observation that the manufacturing industry has the lowest market capitalization among all sectors, as a high quick ratio indicates inefficient use of cash and cash equivalents.
Firm’s market capitalization does not affect to their trading both in buying and selling, it just only affects to their long term position via their ownership ratio.
Conclusions
The study reveals that a firm's market size does not significantly impact its overall buying and selling decisions However, it does influence purchasing choices specifically within the finance and construction sectors, as well as selling decisions in the finance industry.
Research indicates that foreign investors favor trading stocks of highly profitable firms for both short-term and long-term investments In addition to Return on Equity (ROE) and Return on Assets (ROA) as key profitability indicators, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) significantly influences their decisions regarding short-term buying and selling, as well as long-term ownership ratios.
The study reveals that foreign investors tend to favor purchasing and holding stocks of firms with low leverage ratios across nearly all industries However, in the construction sector, they predominantly sell stocks of firms with high leverage ratios, aligning with the hypothesis Conversely, in the finance industry, foreign investors sell stocks of firms with low leverage ratios, and in the manufacturing sector, they also exhibit selling behavior, though the latter findings are not statistically significant.
The study indicates that the quick ratio is a more statistically significant measure of a firm's liquidity compared to the current ratio While there is a mixed relationship between liquidity and ownership ratio, the findings are not statistically significant enough to draw definitive conclusions Additionally, although liquidity shows a positive correlation with buying and selling volume across the entire sample, this correlation is not statistically significant However, when analyzed by individual industries, liquidity demonstrates partial significance in each sector.
The firm's dividend policy shows a positive correlation with the ownership ratio across various industries, although this relationship is not statistically significant Similarly, the connection between dividend policy and trading volume is generally consistent across most industries; however, in the finance sector, foreign investors tend to favor trading stocks of companies that offer low dividend yields.
Policy recommendation
Domestic investors should prioritize firm size and profitability, as indicated by EBITDA, when making short-term investment decisions in the construction sector for buying and the manufacturing sector for selling This approach is more effective than relying on traditional metrics like ROE or ROA.
Investors should exercise caution when using the price-to-book (PB) ratio to assess potential stocks, particularly in relation to foreign investors' trading behaviors Foreign investors often engage with stocks that exhibit a low PB ratio This is particularly relevant in the construction sector, where it is crucial to analyze the selling or buying position in conjunction with the stock's price-to-earnings (PE) ratio, whether it is high or low.
Investors considering long-term investments in companies that thrive on foreign ownership should carefully analyze their net purchase positions and debt ratios Generally, a higher net purchase and a lower debt ratio indicate a more favorable investment opportunity Additionally, for construction firms, evaluating the EBITDA indicator is crucial for making informed long-term investment decisions.
To attract foreign investors, listed companies must carefully evaluate their financial leverage, as a higher leverage ratio may diminish their appeal.
Construction firms must strategically assess their appeal to foreign investors, as construction-related stocks are currently overpriced To attract foreign investment, these companies should focus on reducing the ownership ratio of such stocks, addressing investor concerns and enhancing market competitiveness.
Government policy plays a crucial role in attracting foreign capital, as evidenced by the positive correlation between net purchases by foreign investors and portfolio equity In years when there is a decline or negative net purchase of foreign investors in the stock market, it is essential to reevaluate and adjust relevant policies or regulations This strategic adjustment aims to enhance the competitiveness of the local market against neighboring emerging countries such as Myanmar and Malaysia.
Standardizing accounting principles for amortization and depreciation to align with global standards is essential Failure to do so may lead to discrepancies in traditional financial indicators like Return on Equity (ROE), Return on Assets (ROA), and Earnings Before Interest and Taxes (EBIT), ultimately affecting their intended purpose and accuracy in measuring a firm's profitability.
The analysis focuses exclusively on large firms within the finance industry, selecting stocks with a market capitalization exceeding VND 100 billion and those that have generated foreign trading activity over the past year.
The study focuses on three specific industries to enhance market appeal It suggests that the trading volume of foreign investors, along with their ownership stakes in smaller companies (market capitalization under VND 100 billion), may reveal their investment strategies This could indicate a tendency to scale these firms into larger entities or even globalize them in the future.
The relationship between net purchases of foreign investors in the Vietnamese stock market and net inflows of portfolio equity into Vietnam is significant across various timeframes, including quarterly, half-yearly, and yearly periods Analyzing these patterns reveals how foreign investment trends influence the overall equity market dynamics in Vietnam Understanding this correlation can provide valuable insights for stakeholders looking to navigate the investment landscape in the country.
Consistent net purchases of stocks by foreign investors over a period can indicate strong momentum, potentially driving up stock prices.
A study should be conducted to analyze the stock returns of foreign investors who hold stocks for an extended period following their initial net purchases in earlier years This research will focus on a portfolio that tracks these net purchases and evaluates the returns over a specified timeframe.
For manufacturing firms, it’s necessary to take a further study about the relationship between foreign investor’s ownership ratio and their structure of owner equity as well as their profitability.
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Appendix 1: Testing multicollinearity among variables by using the variance inflation factor for the whole sample:
Variable VIF 1/VIF Variable VIF 1/VIF Variable VIF 1/VIF
PE 1.12 0.892 Mean VIF net_buy 1.14 0.8786
Ownership Ratio variable for whole sample
Buy volume variable for whole sample
Sell volume variable for whole sample
Appendix 2:Testing multicollinearity among variables by using the variance inflation factor for the finance sample:
Variable VIF 1/VIF Variable VIF 1/VIF Variable VIF 1/VIF
Q_Ratio 1.27 0.7888 Mean VIF net_buy_fin 1.11 0.9045
Sell volume variable for Finance sample
Ownership ratio variable for Finance sample
Appendix 3:Testing multicollinearity among variables by using the variance inflation factor for the construction sample:
Variable VIF 1/VIF Variable VIF 1/VIF Variable VIF 1/VIF
Mean VIF Mean VIF net_buy_con 1.33 0.751
Ownership ratio variable for Construction sample
Sell volume variable for Construction Sample
Appendix 4:Testing multicollinearity among variables by using the variance inflation factor for the Manufacturing sample:
Variable VIF 1/VIF Variable VIF 1/VIF Variable VIF 1/VIF
PE 1.79 0.559 PE 1.79 0.559 net_buy_man 1.37 0.732
Mean VIF Mean VIF Mean VIF
Sell volume variable for Manufacturing sample
Ownership variable for Manufacturing sample
Appendix 5: Correlation Matrix of variables:
All samles buy sell net_buy own MKC PE PB EBITDA ROE ROA DIV Debt Q_Ratio C_Ratio buy 1 sell 0.86 1.00 net_buy 0.17 -0.35 1.00 own 0.27 0.19 0.13 1.00
Finance buy sell net_buy own MKC PE PB EBITDA ROE ROA DIV Debt Q_Ratio C_Ratio buy 1.00 sell 0.88 1.00 net_buy -0.23 -0.66 1.00 own 0.15 0.09 0.06 1.00