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Predicting Financial Performance Of Publicly Traded Turkish Firms: A

Comparative Study

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Predicting Financial Performance Of Publicly Traded Turkish Firms: A

Comparative Study

Ozgur Turetken

Fox School of Business and Management

Temple University Philadelphia, PA, USA.

Tel: (1) 215 204 3058

Fax: (1) 215 204 3101

E-mail: turetken@temple.edu
 Predicting Financial Performance Of Publicly Traded Turkish Firms: A

Comparative Study

Abstract

This study aims to predict the financial performance of publicly traded Turkish firms

using their available financial data. Financial performance is measured by a firm’s inclusion in

an index of top performers, where the inclusion of firms is based on the value and sales volume

of their stocks. Two alternative techniques, multiple discriminant analysis and neural networks,

are used for this prediction problem, and their prediction accuracy is compared. The results

suggest that the chosen financial ratios lead to useful predictions with both techniques, where

neural networks perform better than discriminant analysis when trained with a larger sample. It

was also found that both techniques provide better predictions for average and poor performers

than they do for top performers without statistically significant differences between the

prediction accuracy of each technique.

Keywords: Artificial Intelligence, Neural Networks, Multivariate Statistics, Financial Prediction,

Decision Support Systems (DSS).

1. Introduction

Prediction of the financial performance of a firm is important for a number of groups that

have interest in the firm. Creditors, auditors, stockholders, and senior management all need a

methodology or model based on some available information that will be helpful in the

identification of internal problems by senior management, evaluation of the firm by investors,

and as a decision making tool for auditors [16,17,21,23,33,35]. Many financial performance

predictions involve the assignment of a firm to one of a number of pre-determined classes. Such

classifications concerning the performance and viability of a firm is a complicated process where

decision makers face large volumes of information to explore [36].

Different techniques, ranging from expert analysis to sophisticated decision support

systems [20], have been used to tackle the classification problem. Among these, statistical

methods have been the traditional way of building such predictive models [31]. The most

frequently used statistical methods for a prediction that involves assignment of an observation to

either one of two prespecified classes (a 2-way classification problem) are multiple discriminant

analysis (MDA), binary logistic regression (logit) analysis, binary probit analysis, and ordinary

least squares methods [11].

More recently, Neural Network (NN) models have gained a lot of popularity as an

alternative to classical statistical models for prediction purposes

[6,7,8,13,15,16,18,25,28,29,30,31,32,33,35]. A comprehensive review of the literature on

finance applications of neural networks shows that while most of the research in the area

suggests that NN models are superior to statistical models in terms of prediction accuracy, the

results are mixed [34]. Further, it has been suggested that the superiority of one class of

techniques over others are case-specific because performance of a technique depends on a

number of factors such as the choice of predictor variables [6], the application domain [15], and

the amount [20], the accuracy [2,22], and other characteristics [14,20] of the data used in the

model. Even studies that suggest a combined statistical and artificial intelligence based

technique stress the importance of determining the context in which each technique is more

successful [24].

To improve our understanding of the mentioned techniques, this paper presents a study of

the predictive capabilities of neural networks and multiple discriminant analysis in a new

domain. The aim of the study is to predict financial performance of publicly traded Turkish

firms using neural networks and discriminant analysis, and to compare their performance. Since

the list of publicly traded Turkish firms is a new data set for such a comparison, the results will

shed light on the generalizability of earlier findings of studies that were done in different

countries. This is important, because possible differences between the findings of this study and

those of others may point to the existence of certain macro variables depending on national

economies or the period of time a study is conducted. Meanwhile, the lack of such differences

would increase our confidence in the relative strength and weakness of each technique.

In addition, we study the effect of training sample size in building the models for its

previously proposed effect on prediction accuracy [20]. Finally, the dependent variable in our

study is financial success measured by a firm’s inclusion in the Istanbul Stock Exchange 100

(ISE100) index rather than failure or bankruptcy, which has been the focus of most previous

work on financial performance [6,8,25,28,30,31,32,33,35]. Accordingly, the results would be

particularly of interest to investors and financial analysts.

The organization of the rest of the paper is as follows. In the next section, relevant

literature on the topic is reviewed. The third section describes the study by displaying the data

4
set, and detailing the research questions. Also, the methods used to build the models, and the

predictive models per se are covered in this section. The results are given in the fourth section,

and the fifth section presents the conclusions.

2. Review Of Relevant Work

Corporate performance prediction has been of interest to scholars for more than three

decades. Much earlier work on financial performance prediction has focused on bankruptcy

cases for their importance to a number of stakeholders such as creditors, auditors, stockholders,

and senior management. Beaver [3] is one of the pioneering researchers to study whether

financial ratios provide useful information in bankruptcy prediction. Altman [1] expanded this

idea, and proposed the use of multiple discriminant analysis (MDA) built on a set of five

financial ratios in bankruptcy prediction. This study found that the MDA model could

successfully predict bankruptcy in 94% of the cases in the sample. Since Altman, MDA models

have been used extensively for the bankruptcy prediction problem [5,19], while logit has

emerged as another popular technique [4]. The major evolution in these studies has been the

identification of different financial and economic ratios that improve predictive performance

[33].

MDA and logit assume certain characteristics of the underlying data such as normality

therefore they are parametric techniques. A neural network model, on the other hand, is non-

parametric since it does not assume the data to have any specific characteristics. This non-

parametric nature of neural network based prediction models has been attractive to researchers

for various kinds of problems that require predictions based on financial variables. Among such

problems are loan application approval decisions [10], prediction of corporate bond rankings and

5
profitability [7], prediction of initial stock prices [16] and stock returns [18], prediction of mutual

fund performance [15], credit card fraud prevention [27], signature forgery detection [9,26] as

well as the continued studies on bankruptcy prediction [6,8,25,28,30,31,32,33,35].

Studies on the use of neural networks on financial performance prediction focused on

comparisons of NN-based techniques with traditional statistical methods. These comparisons

have been made on various dimensions, and the effect of different model-building decisions on

the relative success of a technique has been studied. For example, Tam [30] and Tam and Kiang

[31] designed a detailed study to compare several models built for prediction of bankruptcies in

the U.S. banking sector in the late eighties. These comparisons were made on the robustness,

predictive accuracy, adaptability, and explanatory capability dimensions. The results suggested

that neural networks offer better predictive accuracy than discriminant analysis, factor-logistic

analysis, k nearest neighbors, and ID3 especially when the data set is multimodal. Neural

networks were also more robust due to their non-parametric nature, and showed better

adaptability in model adjustment. On the other hand, the studies observed that neural networks

are harder to configure, computationally inefficient, and lacked the explanatory capability of

some of the statistical methods such as logit.

In another study, a neural network was trained to predict thrift failures and the resultant

model was evaluated using a logit model as a performance benchmark for correct classification

ratios [28]. This study found that the neural network, which uses the same financial ratios as the

corresponding logit model, achieves a higher degree of prediction accuracy, and is more robust.

Fletcher and Goss [8] used company failure data to build a neural network and a logit model, and

found that the neural network technique more accurately predicts bankruptcy than the logit

model.

6
 Wilson and Sharda [33] designed a comprehensive study to compare the prediction

accuracy of neural networks and multiple discriminant analysis using bankruptcy data. Using

simulation, the authors created 180 different training and test samples with one of three differing

ratios of bankrupt and non-bankrupt firms in each subsample. Their major findings were that the

neural networks outperform discriminant analysis in almost all cases, and the composition of the

training set has a significant effect where the best training was achieved when the ratio of the

bankrupt cases in the training sample was 50%.

Tsukuda and Baba [32] used 48 different neural network models to predict Japanese

corporate bankruptcy, and compared the results to those of multiple discriminant analysis. The

comparison suggested partial support for neural networks such that the neural networks were

superior in the classification of non-bankrupt firms, whereas both techniques were equivalent in

the classification of bankrupt firms.

Boritz and Kennedy [6] found that the performance of neural networks in comparison to

that of discriminant analysis, logit, and probit is effected by the choice of variables and sampling

error in the learning sample. It was also noted that the performance of a back propagation neural

network is sensitive to the number of hidden processing elements.

A study by Luther [25] developed a prediction model using neural networks for the

outcome of bankruptcy, based on the firm’s financial ratios at the time of filing for Chapter 11.

The performance of the neural network models varying on parameters such as the cut-off points

was compared to that of a logit model tested on the same data set. The conclusion was that the

neural network approach is more robust than logit in predicting the outcome.

Although most of the literature seems to agree that neural networks are better predictors

of financial performance, the agreement is not unanimous. For example, contrary results were

7
found in [35] where the discriminant analysis outperformed different kinds of neural network

models in predicting bankruptcy in the oil and gas industry.

This brief review of the relevant work shows that for a number of reasons that may or

may not be controlled by the model builder, the relative success of neural networks over

statistical methods is case specific. Although there is general agreement that neural networks are

more robust and statistical techniques such as discriminant analysis are easier to compute and

interpret, the predictive accuracy of each technique depends on the data. For these reasons, this

study compares the relative performance of neural networks and multiple discriminant analysis

in a different context. What makes the context different is the data set, which is different from

what has been previously studied, and the choice of independent and dependent variables. The

next section discusses the characteristics of the data set and variables.

3. Data And Methodology

3.1 Data and Variables

The data set is taken from the Istanbul Stock Exchange (ISE) bulletins and includes the

firms whose stocks were traded on ISE in 1998. The total sample size is 283. As a surrogate for

financial performance, the ISE 100 index listings are used. The ISE 100 list is formed by

ranking the firms by their market values, which is the product of the number of stocks and the

price of each stock. The top firms in this ranking are included in the index. Normally, the

number of firms included is 100. However, for various reasons that are not relevant to this study,

the exchange may decide that not all 100 firms will be included, and the list is made shorter. For

example, the data set used in our study has 94 firms in the index. The ISE 100 index is updated

quarterly, and the inclusion of a firm is a decision based on its activities from the previous year.

8
Therefore, whether a firm is in the index for the first quarter of the year 1999 is considered to be

an indicator of its financial performance in 1998. Subsequently, our dependent variable is

assigned a value of 1 if a firm is listed on the ISE 100 index in the first quarter of 1999, and a

value of 0 otherwise. We believe this approach to represent financial performance is useful since

the ability to predict top performers in the stock market would facilitate a quick and easy first

step in stock selection.

Financial (accounting) ratios of a firm are arguably better measures of a firm’s current

performance than the individual items on the financial statement (Brigham et al. 1999).

Accordingly, the independent (predictor) variables in the study are financial ratios. It has been

established in the literature (for example, [23]) that the ratios that have predictive power for

financial performance can be grouped under three main categories: 1. profitability, 2. debt, 3.

liquidity and activity. Based on the availability of data, two profitability (return on total assets,

basic earning power), two debt (debt ratio, paid in capital by total assets), and one activity (book

value by total assets) variables are used in this study. The following is a brief description of

these variables:

- NP/TA (Return on Total Assets): This is the ratio of the net profit to total assets of a firm and

shows the after-tax return on total assets.

- EBIT/TA (Basic Earning Power): This ratio is calculated by dividing earnings before interest

and taxes by total assets. This ratio shows the raw earning power of the firm’s asset before

the influence of taxes and leverage, and is useful for comparing firms with different tax

situations and different degrees of financial leverage.

9
- FD/TA (Debt ratio): This ratio is calculated by dividing the sum of current liabilities and

long-term debt by total assets. Debt ratio measures the percentage of funds provided by

creditors.

- PIC/TA (Paid in Capital/Total Assets): This is similar to debt ratio; it measures the

percentage of funds coming from the firm’s capital.

- BV/TA (Book Value/Total Assets): Book value of a firm’s stock is the ratio of the common

equity of the firm to the number of shares.

3.2 Brief Review of the Prediction Techniques

3.2.1 Multiple Discriminant Analysis

Discriminant analysis is based on the formulation of a function that produces the

maximum degree of separation between two groups (i.e. the two levels of the dependent

variable). This discriminant function is either a linear combination of the attributes (i.e.

independent variables) in the model, or a nonlinear transformation of such a linear combination.

The linear discriminant function for multiple discriminant analysis (MDA) is of the following

form (Denton et al. 1990):

y = (X1avg – X2 avg)tS-1X (1)

where

X: the attribute (independent variable) vector for an observation,

X1avg : the vector for the sample mean for group 1,

X2avg : the vector for the sample mean for group 2,

S: pooled variance covariance matrix.

10
 Observations are classified as 1 if y is less than a cut-off value or as 2 otherwise. The

cut-off value is determined by averaging the y values for all observations. This procedure

generates a discriminant function based on linear combinations of the predictor variables, which

provide the best discrimination between the groups. The function is generated from a sample of

observations for which group membership is known. The function can then be applied to new

observations with known predictor variables but unknown group membership.

As a general rule, the discriminant function is constructed using a portion of the sample

data while the rest of the sample is used to test the performance of the function in classifying

new data. These two samples are called analysis and test (hold-out) samples respectively.

3.2.2 Neural Networks

Neural Network (NN) models are among the most popular machine learning techniques

used for prediction. Neural Networks are biologically inspired statistical tools [33]. In a neural

network model, there are two or more layers in which there are individual processing elements,

called neurons. Each neuron has an input and an output connection point. Neurons are joined to

one another in the same or different layers. There is a weight associated with each connection

and these weights are used to calculate the weighted combination of the “signals” that a neuron

receives and processes (i.e. applies a nonlinear transformation). As a result of this neural

processing, an output signal is produced and sent to other neurons that the output point is

connected to. This signal is used by the receiving neurons as input. These neurons in different

layers and the weighted connections between them constitute the neural network.

In a typical feed-forward neural network, information flows from the input neurons (in

the input layer) to the output layer of the network through hidden layer(s). The output (at the

11
output layer) thus produced is compared to the actual output and the difference between the two

is used as feedback to the input and hidden layers for adjusting the connection weights. This

approach is one of the most popular neural network training methods known as

“backpropagation”. The backpropagation network is presented with many such input/output data

pairs before it starts mapping the relationships between dependent and independent variables in

numeric data. This process is the actual training of the network, and like the human brain, the

memory or “knowledge” of the resulting network is not stored in a particular location, but in the

overall pattern of connections that determine the network’s architecture. The result is a

computational system capable of “learning from experience” and therefore increasing the

computer’s ability to perform more “natural” tasks such as pattern recognition.

After training (lowering the output error to an acceptable level), the network model is

“tested” by taking a set of new input data that were not used in training, and by feeding it into the

network to observe the output it will produce. The resulting output “guess” is then compared to

the known answer and an accuracy measure is calculated. This helps in determining how well

the neural network has “learned” to place the correct dependencies and weights to the various

inputs to produce an output.

3.3 Research Questions

In this study we try to answer a number of research questions. First, since it has been

proposed that the choice of predictor variables affects the performance of a prediction technique

[6], we would like to see whether the set of financial ratios we have chosen is actually a good

predictor of financial performance.

12
 Next, we would like to compare the predictive accuracy of multiple discriminant analysis

(MDA) and neural networks (NN) on the specific data set of this study. It has been proposed

that the size of the training sample affects the relative performance of different prediction

techniques [20] where neural networks perform better with a larger sample size. Therefore we

would like to study the effect of training sample size in comparing neural networks and

discriminant analysis. The suggested lower limit for the analysis (training) sample size for

discriminant analysis is 20 times the number of independent variables [12]. Based on that, the

analysis subsample size in this study should be at least 100. On the other hand, when the training

sample size is too large, neural networks tend to “overfit” the model to data, which is

occasionally referred to as “memorizing” the data. Memorization degrades the neural network

performance due to the failure of the models to generalize. Therefore, we wanted to avoid

memorization. For this reason, we imposed an upper limit on the size of the training sample size,

and set that limit to half of the overall sample size. This way, we obtained two training sample

sizes: the “small” sample includes 100 cases (firms), and the “large” one includes 141 cases.

Our final research question concerns the observation that the cost of misclassification in

financial predictions is not the same for good performers and poor performers [32,33]. As it is

more costly to decide that a “to go bankrupt” firm will survive than to decide that a healthy firm

will go bankrupt in bankruptcy studies, we argue that it is more costly to classify an average or a

poor performer as a top performer than classifying a top performer as a poor or average one.

Therefore we also compare neural networks and discriminant analysis for the correct

classification of both groups of firms (i.e. ISE 100 firms and others).

13
3.4 Models

3.4.1 Multiple Discriminant Analysis (MDA)

The multiple discriminant analysis method operates on the assumption that the data for

the independent variables are normally distributed. To test for normality, normal p-p plots have

been drawn for each of the five independent variables as depicted in the appendix. For these

plots and the subsequent statistical analyses of the study, Statistical Package for Social Sciences,

SPSS is used. The p-p plots suggest that the return total assets, the basic earning power, and the

debt ratio can be considered normally distributed for practical purposes. However, the deviation

from normality for the “book value to total assets ratio” (BV/TA) and “paid in capital to total

assets ratio” (PIC/TA) variables is considerable. As a remedy, these variables are put through a

logarithmic transformation, and the distributions of the resulting variables are found to be

normally distributed for all practical purposes. These two “transformed” variables and the three

remaining “untransformed” variables are used to build the MDA.

As discussed before, two MDA models, one with an analysis (training) sample size of

100 cases (firms), and another with an analysis sample size of 141 cases are built. The model

with 100 cases in the analysis sample is arbitrarily called MDA1 while the other one is called

MDA2. The total sample size in the study is 283, therefore the test sample size in MDA1 is 183,

and that in MDA2 is 142.

The analyses are performed using the stepwise model. To avoid a possible bias towards

the larger group, equal prior probabilities for the two groups are set. This way, the best chance

results are limited to a classification accuracy level of 0.50.

14
3.4.1.1 MDA1

MDA1 divides the total sample into an analysis sample of 100 cases, and a test sample of

183 cases. An important assumption in MDA is the equality of the variance-covariance matrices

across the different groups. This equality means that the cases from different groups come from

similar data generation processes, and this is particularly important for a model to have

explanatory capability. Box’s M tests are used in MDA to test whether this equality is valid or

not. Figure 1 depicts the Box’s M test results, and it is seen that the variance-covariance

matrices are significantly different between the two groups (p = 0.034). This means that this

model only has predictive power but no explanatory power. In other words, the subsequent

discriminant function cannot be used to examine the effect of the individual variables on the

dependent variable. This is not a particular problem since the purpose of the study is the

comparison of the predictive capabilities of the models. Furthermore, neural networks, in

general, are not used for explanatory purposes hence the lack of explanatory capability of the

MDA models does not hurt the comparisons. The correct classification rates of MDA1 are

displayed in Table 1.

------------------------------------------Figure 1 approximately here---------------------------

3.4.1.2 MDA2

This is the model that divides the total sample into equal-sized (i.e. 141 vs. 142) analysis

and test subsamples.

------------------------------------------Figure 2 approximately here---------------------------

15
 The Box’s M test results in Figure 2 suggest that the variance-covariance matrices in the

sample of this analysis are significantly different between the two groups (p=0.027). Similar to

the previous model, the discriminant function here is good for prediction purposes only. The

correct classification rates of MDA2 are also displayed in Table 1.

3.4.2 Neural Networks (NN)

The NN model with 5 input (one for each predictor), 8 hidden, and 2 output nodes is built

using ThinksPro – Neural Networks for Trial Version. The network is built on a multi-layer

normal feed-forward architecture. Each node in the output layer is a dummy variable and takes a

value of 1 if a case belongs to the class that the node represents and 0 otherwise. The sigmoid

function (t(f) = 1/(1+exp(-f))) is used for transforming the incoming signal to output at each

node. The input data to the network are preprocessed by performing a z-transformation, i.e., for

each case and every independent variable in the data set, a z-score is calculated by taking the

difference between the independent variable value of a specific case and the average of that

independent variable over the entire data set, and dividing this difference by the standard

deviation of the variable. The sigmoid function has an S-shaped curve, and its value is virtually

constant unless the input to the function is within a certain interval. When inputs from outside

this interval are used in the network, this phenomenon of having a constant output value

materializes, and this is known as the saturation of the network. The z-transformation is required

to avoid saturation especially when the sigmoid function is used at individual nodes.

The network is trained using the backpropagation (BPN) algorithm, and is considered

“trained” when the (mean standard) classification error reaches a local minimum. This decision

16
is the result of a judgment call. The classification error is defined as the root mean square of the

total error at the output layer.

As was the case in the MDA models, two neural networks are trained. The model with

100 cases (firms) in the training (analysis) sample is called NN1, and the one with 141 cases in

the training (analysis) sample is called NN2.

3.4.2.1 NN1

The classification error as described above on the network trained on 100 samples

reaches a local minimum after 900 iterations where the mean standard error is approximately

0.30. The correct classification rates of NN1 are displayed in Table 1.

3.4.2.2 NN2

The classification error on the network trained on 141 samples reaches a local minimum

after 800 iterations where the mean standard error is approximately 0.27. The correct

classification rates of NN2 are also displayed in Table 1.

4. Results

Three predictive performance measures for the predictive models are defined:

1. group 1 (ISE100 firms) correct classification rate, 2. group 2 correct classification rate, 3. total

correct classification rate. These measures belonging to the predictive models developed in the

study are shown in Table 1.

------------------------------------------Table 1 approximately here---------------------------

17
 Our first research question is regarding whether the set of our chosen financial ratios can

successfully predict financial performance. To assess the value of the predictor set, we use

Press’s Q statistic. Press’s Q statistic is a test to determine whether the model results are

significantly better than those that would be obtained by chance only [12]. Press’s Q statistic is

calculated as follows:

Press’s Q = (N – (n*k) )2 / (N * (k – 1)) (2)

where

N = total sample size

n = number of observations correctly classified

k = number of groups.

The value of Press’s Q for the test samples are as follows:

(183 – 110 * 2)2 / (183 * (2 – 1)) = 7.48 for MDA1

(142 – 90 * 2)2 / (142 * (2 – 1)) = 10.17 for MDA2

(183 – 105 * 2)2 / (183 * (2 – 1)) = 3.98 for NN1

(142 – 97 * 2)2 / (142 * (2 – 1)) = 19.04 for MDA2

The critical value of Q (Chi-square value for 1 degree of freedom at the desired

confidence level) at a significance level of 0.05 is approximately 3.84. Based on this, all the

results of our models are better than chance values. Accordingly, we suggest that the predictor

variable set produces acceptable predictions both for MDA and NN.

18
 The second research question we wanted to tackle was regarding the relative performance

of MDA and NN in accurately predicting the performance of firms. An examination of the

results of Table 1 shows that the comparison of MDA and NN cannot be made without

considering the effect of training sample size such that NNs outperform MDA (68.3% vs. 63.4%)

when the training sample is large while MDA outperforms NN (60.1% vs. 57.4%) when the

training sample size is small. Figure 3 is a graphical display of these results.

------------------------------------------Figure 3 approximately here---------------------------

Our last research question concerns the relative performance of neural networks and

discriminant analysis for the correct classification of top financial performers (i.e. ISE 100 firms)

versus others. As seen in Table 1, both neural networks and discriminant analysis are better at

correctly classifying non-ISE 100 firms than ISE 100 firms. To test whether this difference is

significant, the non-parametric Wilcoxon signed-rank test is used. The Wilcoxon signed-rank

test is a procedure used with two related variables to test the hypothesis that the two variables

have the same distribution. This test takes into account information about the magnitude of

differences within pairs and gives more weight to pairs that show large differences than those

that show small differences. The test statistic is based on the ranks of the absolute values of the

differences between the two variables.

The Wilcoxon signed-rank test results displayed in the top portion of Figure 4 suggest

that the difference between the correct classification rate of ISE 100 firms and non-ISE 100 firms

(non-ISE 100 > ISE 100) is borderline significant (p = 0.068). To test whether the difference

between groupwise classification rates are technique dependent, we examine the difference in

19
groupwise classification rates for MDA and NN separately (Table 2). As seen in the bottom

portion of Figure 4 and Table 2, neural networks and discriminant analysis are not significantly

different (p = 0.180) in terms of differences between groupwise classification rates. Rather, the

difference in correct classification rate between groups depends on the training sample size. In

the next section, we discuss the implications of these results, and draw conclusions.

------------------------------------------Figure 4 approximately here---------------------------

------------------------------------------Table 2 approximately here---------------------------

5. Discussion And Conclusions

This paper aimed to explore whether the financial performance of the firms whose stocks

are traded in the Istanbul Stock Exchange (ISE) could be predicted using a set of available

financial ratios. Our test results showed that both the multiple discriminant analysis and the

neural network models built using this set of ratios of the 283 publicly traded firms yielded

predictions that are better than chance values, and are therefore usable for predictive purposes.

Our analyses were performed for a data set that was not analyzed in this context before, therefore

the findings confirm the validity of predicting financial performance by firm-level variables

independent of differing macro conditions such as national economy.

We observe that the correct classification rates for the test samples were between 57.4%

and 68.4%, which are lower than the typical figures reported for bankruptcy prediction models,

which are typically above 90%. However, it should be noted that unlike bankruptcy prediction

models, this study uses a market value-related variable to represent financial performance.

Although market value of a firm depends on its performance, it is also affected by other factors

20
such as the macro-level economical and political state of the country, and stock market

conditions. Therefore being able to predict stock performance solely by micro-level variables is

nontrivial, and would be a good tool for financial analysts and individual investors. On the other

hand, despite the good results of our models, we believe their value will be best utilized if

complemented by macro level predictions and other widely used techniques such as time series

forecasting. Details of how such integrative models should be built were beyond the scope of

this paper, but would be an interesting direction for future research.

The previous literature reviewed in section 2 suggested that the neural network models

would outperform discriminant analysis in classification accuracy. The results of this study

suggest that this is only true if the neural network model is trained with a large enough data set.

Our conclusion is that neural networks would be particularly useful for macroeconomic studies

where the data set is typically very large whereas for data samples that have sizes around the

recommended minimum for discriminant analysis, neural networks would not perform to their

best capacity. Our recommendation for such cases is to prefer traditional statistical models

especially given the complexity of neural networks, their level of sensitivity to model building

decisions, and the time it takes to build them. Earlier work with simulated data [20] also

suggests that neural networks perform significantly better when the training sample size is large,

however the results do not provide a minimum training sample size recommendation. Although

we did not test the comparative performance of the techniques over a continuously changing

range of the training sample size, we were able to see a difference for the larger training sample

size, which is roughly 28 times the number of independent variables. Here, we were limited by a

data set of certain size, but future research should study whether a certain multiple of the number

of independent variables (for example, a conservative suggestion would be 30) could be a good

21
cut off point for neural networks to outperform discriminant analysis. Likewise, the size of our

sample also limited us from observing a good upper limit for neural network training sample

sizes beyond which over-fitting (i.e. memorization) would occur, and that remains to be an open

area for future research.

Our results also showed that using the predictor variable set, both the discriminant

analysis and neural network models had a propensity towards the average or poor performing

firms hence the classification rates for these firms are significantly better than those in the top-

performing group. It can be argued that the “cost” of classifying a poor or average performer as

a top performer is higher than classifying a top performer as an average or poor performer. For

that reason, the predictions of our models may be better than just a simple average of the correct

classification rates of each group since they perform better when the misclassification cost is

higher. On the other hand, there was no significant difference between discriminant analysis and

neural networks in terms of the relative performance in classifying each group. Therefore, our

results fail to provide a recommendation as to what technique to use for problems where the

misclassification cost is largely different for different groups of observations.

Acknowledgement: I am sincerely grateful to Dr. Seza Danisoglu from M.E.T.U. (Ankara,

Turkey) for her guidance in the early stages of this research.

22
Appendix

- Normal P-P Plots

Normal P-P Plot of BV/TA

1.00

.75

.50
Expected Cum Prob

.25

0.00
0.00 .25 .50 .75 1.00

Observed Cum Prob

Normal P-P Plot of EBIT/TA

1.00

.75

.50
Expected Cum Prob

.25

0.00
0.00 .25 .50 .75 1.00

Observed Cum Prob

Normal P-P Plot of FDEBT/TA

1.00

.75

.50
Expected Cum Prob

.25

0.00
0.00 .25 .50 .75 1.00

Observed Cum Prob

23
 Normal P-P Plot of NETP/TA
1.00

.75

.50
Expected Cum Prob

.25

0.00
0.00 .25 .50 .75 1.00

Observed Cum Prob

Normal P-P Plot of PIN/TA

1.00

.75

.50
Expected Cum Prob

.25

0.00
0.00 .25 .50 .75 1.00

Observed Cum Prob

24
- Normal P-P Plots Of The Transformed Variables

Normal P-P Plot of PIN/TA

1.00

.75
Expected Cum Prob

.50

.25

0.00
0.00 .25 .50 .75 1.00

Observed Cum Prob

Transforms: natural log

Normal P-P Plot of BV/TA

1.00

.75
Expected Cum Prob

.50

.25

0.00
0.00 .25 .50 .75 1.00

Observed Cum Prob

Transforms: natural log

25
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Figures

Figure 1
Box’s M Test Results for MDA1

Box's M 4.563
F Approx. 4.497
df1 1
df2 13219.585
Sig. .034

Figure 2
Box’s M Test Results for MDA2

Box's M 4.927
F Approx. 4.874
df1 1
df224536.062
Sig. .027

Figure 3
Correct Classification Rate versus Sample Size

70.00%
Correct clasification rate

68.00%
66.00%
64.00%
62.00%
MDA
60.00%
58.00% NN
56.00%
54.00%
52.00%
50.00%
100 140
Sample size
Figure 4
Comparison of Groupwise Correct Classification Rates Wilcoxon Signed-Rank Test
Results

a. Both techniques combined

NONISE100 -
ISE100
Z -1.826
Asymp. Sig. (2-tailed) .068

b. Neural networks vs. discriminant analysis

NN - MDA
Z -1.342
Asymp. Sig. (2-tailed) .180

31
 Tables

Table 1
Correct Classification Rates

Group 1 (ISE100) Group 2 (NON Total correct

correct ISE100) correct classification rate
classification rate classification rate
MDA1 Analysis 43.8% 70.6% 62.0%
MDA1 Test 59.7% 60.3% 60.1%
MDA1 Overall 54.1% 63.9% 60.9%
MDA2 Analysis 47.6% 63.6% 58.9%
MDA2 Test 44.2% 74.4% 63.4%
MDA2 Overall 45.9% 69.0% 61.2%
NN1 Analysis 76.5% 93.9% 88.0%
NN1 Test 56.7% 60.7% 57.4%
NN1 Overall 63.8% 72.7% 68.2%
NN2 Analysis 87.2% 91.5% 90.1%
NN2 Test 46.8% 77.9% 68.3%
NN2 Overall 68.1% 84.7% 79.2%

Table 2
Correct Classification Rates by Groups

Group 1 (ISE100) Group 2 (NON Difference in

correct ISE100) correct correct
classification rate classification rate classification rate
MDA1 Test 59.7% 60.3% 0.6%
MDA2 Test 44.2% 74.4% 30.2%
NN1 Test 56.7% 60.7% 4.0%
NN2 Test 46.8% 77.9% 31.1%

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