A SPECIAL AND UNDERVALUED STOCK MARKET



A SPECIAL AND UNDERVALUED STOCK MARKET

IN TAIWAN

[1]Yao-Chun Tsao, Cheng-Shiu University & I-Shou University

Wen-Kuei Chen, I-Shou University

Abstract

The “managed stock” market in Taiwan is neglected by the authorities and general investors. In our paper, we explored the link between financial trait and stock price changing in that special market. Overall, the authors analyze and discuss managerial implications for institutional investors, general investors and the authorities as well.

Keywords: managed stock; financial distress; stock market; OTC

Introduction

The stock market in Taiwan has fairly developed since 1960s. It helps many businesses expand and strengthen themselves and provides the public with a proper channel for investment. Besides, it leads to the upgrade of entire industries and enhancement of competitiveness. On the other hand, by the rapidly-enlarging scale of Taiwan’s stock market and the magnificent foreign funds inflow, it has emerged as one of the most important stock market in Asia.

Like the other Asian countries, Taiwan’s economy was shocked by financial risk in Asia and global involve in depression around 1998. Taiwan’s stock market seriously plunged, too. And there are many business distress cases occurred in that special time. Most reasons include abnormal trade, insider trading and assets deceit, etc. Take examples, they are Jui-Lien Corporation, Han-Yang Group (Kuo-yang, Kuang-Yu), Hsin-Chu-Chun Group (Ya-Se technology, Tai-fang, Pu-ta), Kuang-San Group (Shun-Ta-Yu, Chung-Chi), Jung-Chou Group (Ta-Kang, Yu-Li), Sakura Group (Taiwan Sakura, Sakura construction), Lien-Cheng, Ta-Ying, Hsin-Yen, Ta-Yung-Hsing, Chin-Wei, Chung-Ching-Chi, Ming-Chia-Li, Feng-An, Hsin-Tai-Shen Copper, Kuo-Tsan Car, Chung-Chiang, Chang-Yi, Hung-Fu, Huang-Pu, Jen-Hsiang, Chien-Mei, Tung-Lung, Yu-Mei, etc.

Regulations are designed to de-list listed companies from stock market mostly focus on those investors are unwilling to invest, such as extreme stockholder concentration, rare trading volume and turnover, too much lower stock price and/or market value. But the practical de-listed events generally are due to individual financial affairs. That is, most listed firms were announced to stop trading temporarily or even de-listed by the authority because of their financial distress. The next question is where are those de-listed firms going to? Many of them transfer to the managed stock market for trading again. Our concern is how about their performance by staying there!

In the period of our study, “managed stock” market included thirteen firms as follows: Tong Lung (code 8705), Victor (code 8707), Tah Chung (code 8708), YiShin (code 8710), CAC (Chinese Automobile Company, code 8712), TIDC (Taiwan Industrial Development Corporation, code 8718), Hung Fu (code 8719), Ensure (code 8720) and Sun Home (code 8721), TaTeh code 8722), Taiyu (code 8723), Lee Tah (code 8724) and Sun Splendor (code 8725). In the viewpoint of investment strategy, we should not ignore the significance of “managed stock” market. Virtually, “managed stock” market still holds its own value and intrinsic importance. For that reason stated above, it is taken for granted that the authorities should care about “managed stock” market, and pay more attention to its stock price and financial performance. In other words, even if a firm with financial distress listed “managed stock”, the authority is obliged to supervise as serious as it could. For general investors, they should keep alarming to “managed stock”, because it might be another grounds that can make fortune.

Research Purpose

Accordingly, the business financial distress was generally ascribed to either artificial mistakes or incorrect policy decision. In fact, a firm’s financial distress is just like a chronic disease. It doesn’t happen suddenly, but gradually in separate stages. The signals of its first stage are the shortage of operating funds and payment delaying; the second stage is the stage of unbalanced financial affairs. Its phenomena are fund turnover difficulty and debts default; the last one goes to bankruptcy. The firm loses the ability to pay off all debts.

Some listed firms stop trading in TSE (Taiwan Stock Exchange) or OTC (Over the Counter) owing to their financial distress. Then, the firms that are regarded worthily to operate by the authorities will apply to list as “managed stock” on OTC. They are allowed improving themselves in certain time. Once they list in “managed stock” market, they will be de-listed in “managed stock” market if their performance couldn’t get better before the deadline.

So the study focuses on whether the firms have appears signals of worse financial status before the happening of financial distress. Moreover, whether do they improve financial status after transferring as “managed stock” and how abut those stock price performed? In addition, whether “managed stocks” get valuation as relatively as TSE or OTC markets?

The firms listed on “managed stock” market may be still somewhat acceptable objects for general. Therefore, our research investigates the relative changes of “managed stock” between stock price and financial performance before and after listed in the stock market in efforts to catch on to the connection between financial distress stock price pattern.

Literature Review

The literatures discussed about “managed stock” in Taiwan are fairly limited. Most of them examine advantage/disadvantage and feasibility about the “managed stock” market. We introduce some informative research offerings of “managed stock” for comprehension.

Also, we synthesize the definitions and regulations of managed stock in the appendix for your reference (see Appendix).

As we know, “managed stocks” list on the special market after de-listed in TSE or OTC. We found that most of them matching these requirements are encountering either hardship in financial condition or shortage of capital. Therefore, we must examine more literatures about the reasons for the happening of financial distress, and discovering the connection and possible relation.

Financial Causality

Financial crisis incessantly occurs in Taiwan in the late twentieth century. Not only did it cause prices plummet, but influence the performance of whole stock market in Taiwan. Moreover, the un-performing loan and default of the companies cause the financial institution worsen and frail. Even the contagion spill over into other well-conditioned companies and also impede economic development. The problem is so serious beyond imagination.

Actually, a firm’s financial distress shed some light to trace. Financial analysis is central to business valuation and business lending decision (Foster, 1978; Palepu et al., 1997). Generally, it results form either artificial mistakes or incorrect policy decisions. Some important tracking indexes and financial ratios are precisely related with the financial distress diagnosis as follows in Table 1.

TABLE 1

Literature Review Summary for Financial Distress

|Researcher |Advocate |

|Zmijewski |Develop weighted profit bankruptcy prediction model including three critical independent variables: ROA, Debt |

|(1984) |Ratio and Current Ratio. |

|Lai |Four financial indexes: Net Return on Investment, Debt Ratio, Quick Ratio, and Operating Income of This Quarter -|

|(1989) |Operating Income of Previous Quarter/ Operating Income of Previous Quarter. |

|Yin |Five low － Current Ratio, Total Assets Turnover Ratio, Return on Total Assets, Return on Total Capital, |

|(1994) |Operating Income Ratio. |

| |One high － Inventory Turnover Raito. |

|Tsai |Six financial indexes － Total Liability/Total Assets, Quick Assets/Current Liability, Operating Grass |

|(1995) |Profit/Operating Income, Earning After Income Tax, Stock Accounts Value, and Stock Cash Divided. |

|Chu |Seven financial indexes: － Return on Stockholder’s Equity, Current Assets Raito, Debt Raito, Accounts Receivable|

|(1996) |Turnover Ratio, Selling Growing Ratio, Revenue Ratio, and Return on Total Assets. |

|Cooper et al. |Advocate eighteen ratio types for different users. The most important ratio is Liquidity and the second one is |

|(1998) |Profitability. |

|Li |Stage of Beginning － Inventory begins to be un-salable and Accounts Receivable appears to be in arrears and |

|(2000) |un-receivable. |

| |Stage of Worsening － Profitability declines sharply. |

| |Stage of Striving － Be lack of operating fund. |

|Chang, Chiu, and Hsu |（1）Higher Debt Ratio and too more financial leverage. |

|(2000) |（2）All profit ratio is much lower than companies. |

| |（3）Accounts Receivable Turnover Ratio goes average worse, and so does Inventory Ratio. |

|Hsiao |Seven critical financial indexes － Debt Ratio, Current Ratio, Quick Ratio, Inventory Turnover Ratio, Fixed |

|(2001) |Assets Turnover Ratio, Net Income/Revenue Ratio, Earning Per Stock. |

|Swamy |Adopt four groups of financial ratios to diagnosis corporate sickness: Liquidity Ratios, Profitability Ratios, |

|(2002) |Turnover Ratios, and Operating Efficiency Ratios. |

|Pan |Four financial indexes － Operating Income/Sales Income Ratio, Inventory/Sales Income Ratio, Total Assets Growing|

|(2002) |Ratio, and Fixed Assets/Total Assets Ratio. |

|Yu |The common phenomena － Such as lack of ability for paying debt, too higher Debt Ratio, too low profit, and so |

|(2002) |forth. |

|Milauskas |The most 5 critical financial ratios are: Liabilities to Net Worth, Current Ratio, ROA, ROS, and ROE. |

|(2003) | |

We can precisely scout the uncertainty of whether financial distress occurs by each financial index so as to further take preventive measures and tactics. This paper synthesizes some precedent studies, finding that we could observe the trends of eight financial ratios－“Debt ratio”, “Current ratio”, “ Quick ratio”, “Accounts receivable turnover ratio”, “Average days for sale of goods”, “Return on total assets”, “Earning per share ”, and “Cash flow ratio”－to discern the signal of financial distress in advance.

Theoretically, there are many causes could make a listed firm into “managed stock” market, from our practical of data analysis, the causes of these thirteen “managed stock” companies in this study－one is because false and concealed items of accounts, one is because the operation items of the business changed substantially. Another three come from the negative net assets, and still other eight are from the records of refusal transactions by the financial company or of check deposit shortage for payment (Table2). All signs comply with literatures claimed above. As a result, the performance of financial ratio can be the measurement and linkage with price performance.

TABLE 2

Reasons and Regulations for De-listed Firms

|Name |Main Reasons |Relative Regulations |

|Tong Lung |The consolidated financial report shows negative net |In accordance with Operating Rules of the Taiwan Stock |

| |assets. |Exchange Corporation－ Paragraph 9 of Article 50-1 |

|Victor |The false and concealed items of accounts still exist at |In accordance with Operating Rules of the Taiwan Stock |

| |the time of the final confirmation of judgment. |Exchange Corporation－ Subparagraph 14-2 of Paragraph 5 of |

| | |Article 50-1 |

|Tah Chung |The scope of the business of the company changed |In accordance with Operating Rules of the Taiwan Stock |

| |substantially. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|YiShin |Records of refusal of transaction by a financial |In accordance with Operating Rules of the Taiwan Stock |

| |institution or insufficient funds on check deposit. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|CAC |Records of refusal of transaction by a financial |In accordance with Operating Rules of the Taiwan Stock |

| |institution or insufficient funds on check deposit. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|TIDC |Records of refusal of transaction by a financial |In accordance with Operating Rules of the Taiwan Stock |

| |institution or insufficient funds on check deposit. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|Hung Fu |Records of refusal of transaction by a financial |In accordance with Operating Rules of the Taiwan Stock |

| |institution or insufficient funds on check deposit. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|Ensure |Records of refusal of transaction by a financial |In accordance with Operating Rules of the Taiwan Stock |

| |institution or insufficient funds on check deposit. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|Sun Home |The consolidated financial report shows negative net |In accordance with Operating Rules of the Taiwan Stock |

| |assets. |Exchange Corporation－ Paragraph 9 of Article 50-1 |

|TaTeh |Records of refusal of transaction by a financial |In accordance with Operating Rules of the Taiwan Stock |

| |institution or insufficient funds on check deposit. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|Taiyu |Records of refusal of transaction by a financial |In accordance with Operating Rules of the Taiwan Stock |

| |institution or insufficient funds on check deposit. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|Lee Tah |Records of refusal of transaction by a financial |In accordance with Operating Rules of the Taiwan Stock |

| |institution or insufficient funds on check deposit. |Exchange Corporation－ Paragraph 8 of Article 50-1 |

|Sun |The consolidated financial report shows negative net |In accordance with Operating Rules of the Taiwan Stock |

|Splendor |assets. |Exchange Corporation－ Paragraph 9 of Article 50-1 |

Method

The samples of this paper are thirteen specific firms listed on “managed stock” market at the end of June, 2003, including Tong Lung, Victor, Tah Chung, YiShin, CAC, TIDC, Hung Fu, Ensure, Sun Home, TaTeh, Taiyu, Lee Tah and Sun Splendor. The main reasons why the listed firms forced to de-list by the authority are the happening of its financial distress. Thus, we summary eight key financial ratios of “managed stock” firms in recent years for empirical study, and also analyzes the performance and trend analysis of financial ratio following listed on “managed stock” market.

Moreover, the authors draw a comparison between the trend charts of the most valuable figure of four dominant financial ratios. They are debt ratio, current ratio, account receivable turnover ratio and return on total assets respectively. By the figures of annual stock prices (the end of month) to observing whether the trend of the charts present positive or negative correlation with their stock performance.

For statistical and economic information, we scrutinize all of each period of stock price of -1 year, -0.5 year, +0.5 year, +1 year and the very right year listed on “managed stock” market to examine whether they get better or worse with t test and signed ranks test. Specially, we take Tong Lung which is in more excellent condition than any other “managed stock” firms for an standard example, enumerating P/E ratio of Tong Lung, average P/E ratio on OTC, average ratio of other sector of stocks on OTC to examine if the relative values of a “managed stock” is undervalued by investors or not.

Discussion

Critical Financial Ratio

Here we explain reasons about the adoption of important financial ratio in this paper.

a. Debt ratio shows how large the debt is in total assets with a view to know the situation of financial structure. The higher debt ratio a company owns, the more credit risk a company has. This index is for the purpose of measuring a company’s long-term capacity to pay debts. Therefore, it is appropriate to examine whether the status of a company’s capital is strongly sufficient or not.

b. Cash flow ratio measures the multiple in cash flow divided by current debt. Net cash flow indicates that in the preceding year so as to predict that a company will produce how much net cash flow of operating activities in the future. This paper omits this ratio because it’s meaning just similar to current ratio.

Current ratio measures a company’s short-term capacity to pay debts, and the risk of poor turnover in short time. Practically, it is more suitable to take the industry average for standard level.

To the greater extent, current ratio is very essential to the use of capital. Much higher current ratio means capital doesn’t be manipulated better enough. In contrast, too lower current ratio means poor capital turnover capacity, tending to result in a company’s failure to emergency operating.

As another point of view, quick ratio, having close resemblance to current ratio, estimates a company’s capacity to pay a short-term debt. Therefore, this paper merely takes current ratio to gauge a company’s capacity to pay the short-term debt.

c. Higher accounts receivable turnover ratio shows cash of accounts receivable is received promptly. In contrary, lower ratio means that is received slowly. Investors can compare a company’s turnover ratio in different time level. If turnover ratio decreases continually or sharply, it could be potential in trouble. In addition, by way of comparison with other companies’ turnover ratio of an industry, we can tell from the accounts receivable turnover ratio is worse or better than the standard of the same industry.

As regards to the other index － average days for cash receipts. It is reasonable we just take accounts receivable turnover ratio for assessing turnover ability since their functions are the same. By this way, this study excludes inventory for cash receipt.

d. Return on total assets presents the efficiency of return by exerting assets. Higher return ratio implies higher efficiency of return. Lower return ratio means lower efficient or excessive investment assets.

For this reason, it is logical that this paper adopts return on total assets to gauge a company’s capacity of earning.

Earning per share also shows a company’s capacity of earning. We herein exclude it because of its same application as return on total assets.

Comparison between Stock Price and Financial Performance

Next, the researchers compare trends of financial ratio with stock price to explore the connected implication. We combine them as Table 3 and Table 4[2] below briefly.

TABLE 3

Linkage between Price Performance and Financial Performance（Before Listed）

|Name |Performance Before|Financial Ratio |Combined Index |Price vs. Index |

| |listed | | | |

| | |Debt Ratio |Current Ratio |Accounts |Return on Total| | |

| | | | |Receivable |Assets | | |

| | | | |Turnover Ratio | | | |

|Victor |↓ |＋worsen |－worsen |－worsen |－worsen |↓ (worsen) |positive |

| | | | | | | |direction |

|Tah Chung |↓ |＋worsen |－worsen |－worsen |－worsen |↓ (worsen) |positive |

| | | | | | | |direction |

|CAC |↓ |＋worsen |－worsen |＋better |－worsen |↓ (worsen) |positive |

| | | | | | | |direction |

|TIDC |↓ |＋worsen |－worsen |＋better |－worsen |↓ (worsen) |positive |

| | | | | | | |direction |

|Ensure |↓ |＋worsen |－worsen |－worsen |＋better |↓ (worsen) |positive |

| | | | | | | |direction |

|Sun Home |↓ |＋worsen |－worsen |－worsen |＋better |↓ (worsen) |positive |

| | | | | | | |direction |

|TaTeh |↓ |－better |－worsen |＋better |－worsen |* (not changed) |irrelevance |

|Taiyu |↓ |＋worsen |－worsen |－worsen |－worsen |↓ (worsen) |positive |

| | | | | | | |direction |

|Lee Tah |↓ |＋worsen |－worsen |－worsen |＋better |↓ (worsen) |positive |

| | | | | | | |direction |

|Sun Splendor |↓ |＋worsen |－worsen |－worsen |－worsen |↓ (worsen) |positive |

| | | | | | | |direction |

TABLE 4

Linkage between Price Performance and Financial Performance（After Listed）

|Name |Performance After |Financial Ratio |Combined Index |Price vs. Index |

| |listed | | | |

| | |Debt Ratio |Current Ratio |Accounts |Return on Total| | |

| | | | |Receivable |Assets | | |

| | | | |Turnover Ratio | | | |

|Victor |↓ |＋worsen |－worsen |－worsen |＋better |↓ (worsen) |positive |

| | | | | | | |direction |

|Tah Chung |↓ |＋worsen |－worsen |＋better |＋better |* (not changed) |irrelevance |

|CAC |↓ |＋worsen |－worsen |＋better |－worsen |↓ (worsen) |positive |

| | | | | | | |direction |

|TIDC |↓ |＋worsen |－worsen |＋better |＋better |* (not changed) |irrelevance |

|Ensure |↓ |＋worsen |＋better |＋better |－worsen |* (not changed) |irrelevance |

|Sun Home |↓ |＋worsen |－worsen |＋better |－worsen |↓ (worsen) |positive |

| | | | | | | |direction |

|TaTeh |↓ |－better |－worsen |－worsen |＋better |↓ (worsen) |positive |

| | | | | | | |direction |

|Taiyu |↓ |＋worsen |－worsen |－worsen |＋better |↓ (worsen) |positive |

| | | | | | | |direction |

|Lee Tah |↓ |＋worsen |－worsen |－worsen |＋better |↓ (worsen) |positive |

| | | | | | | |direction |

|Sun Splendor |↓ |＋worsen |－worsen |＋better |＋better |* (not changed) |irrelevance |

TABLE 5

Returns of Individual Stock (Before and After Listed)

|Name |-1 year |-0.5 year |0.5 year |1 year |

|Tong Lung |-87.74% |-6.81% |-40.09% |338.67% |

|Victor |-230.24% |-13.43% |-84.77% |-92.47% |

|Tah Chung |-93.16% |-94.62% |61.29% |1.00% |

|YiShin |-63.95% |-79.25% |-93.64% |-98.72% |

|CAC |-97.30% |-73.00% |-45.28% |-65.09% |

|TIDC |-91.92% |-84.18% |-53.36% |-47.15% |

|Hung Fu |-11.11% |135.29% |1.00% |200.00% |

|Ensure |-59.62% |-65.39% |-61.00% |-10.55% |

|Sun Home |-37.02% |-10.16% |80.06% |-41.47% |

|TaTeh |-53.24% |-73.78% |-27.74% |-69.94% |

|Taiyu |202.16% |6.25% |21.42% |80.06% |

|Lee Tah |-47.72% |-57.40% |78.26% |63.04% |

|Sun Splendor |-56.65% |-86.40% |28.57% |1.00% |

TABLE 6

Difference Test for stock Returns

|Items |-0.5 year |0.5 year |-1 year |1 year |

|Mean |-0.39 |-0.10 |-0.56 |0.20 |

|Variance |0.39 |0.36 |0.87 |1.60 |

|t value |-1.23 |-2.03 |

|P (T ................
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