A study of the relationship between liquidity ratios and share performance of companies listed on the Nairobi Stock Exchange

Abstract

Share performance is determined by the positive increases in prices together with the dividend distributions during the period. The classical economic view posits that the current price of a stock closely reflects the present value of its future cash flows (Kumar and Charles, 2006). According to this view, the correlations in the returns of two assets arise from correlations in the changes in the assets' fundamental values, with demand shocks or shifts in investor sentiment playing no role because the actions of arbitrageurs readily offset such shocks. This indicates that liquidity ratios may have an impact on share prices as they are likely to affect the organization's fundamental asset values. This paper thus sought to determine the extent to which firm liquidity affects the share prices of the listed firms. To document the return patterns as well as obtain residuals for hypothesis testing, financial ratio data to measure liquidity was computed from published reports of the quoted companies for the years 1997 to 1999 while to measure share performance the share prices were obtained from NSE trades. An empirical study was conducted using NSE listed firms as the population. The findings of the study were that share prices were adversely affected by a decline in firm liquidity. The results indicated that there exists a general association between the firm's current ratio and quick ratio and its stock return, but the association is structurally unstable. It was noted that from 1997 to 1999 the means of the share returns of the firms declined with a reduction in the liquidity levels of the firms.