Discovering the Relationship Between DEA-Based Relative Financial Strength and Stock Price Performance

Abstract

This paper examines the correlation between the relative financial strength of public firms and their stock price performance. By using financial information obtained from the firms' publicly available financial statement as inputs and outputs in Data Envelopment Analysis CCR model, a relative financial strength of a firm is determined relative to other competing firms operating in the same market segment. The aim here is to verify if such a strength index can be strongly positively correlated with the stock market returns, and to develop statistical tests that are necessary to establish the significance of that correlation. We present preliminary computational testing of the strength index with stocks from various industries and report the correlation analyses to support the validity of the approach. Based on the correlation, a well-informed assessment can be made for stock selection in investment portfolios.