The Validity of the Dividend Discount Model in Determination of Growth Stock Performance in the Nairobi Securities Exchange

Abstract

The widespread lack of investor education on stock market investment and persistent information asymmetry in the securities market in Kenya and in the greater financial world has cost investors a pretty penny, and they have incurred great financial loss while making their investment decisions. This study contributes by finding out what one of the methods of investment analysis; the dividend discount model can contribute to solving this investment problem. The purpose of this project was to determine the validity of the dividend discount model in determination of growth stock performance in the Nairobi Securities Exchange. The DDM assumption of multiple growth periods was tested to evaluate its validity. Stratified sampling was used in the sample selection for the study. The research involved a historical longitudinal study of the financial data released by the listed growth stock firms in the NSE. The population of the study comprised 17 growth stocks listed in the Nairobi Securities Exchange as at 31st December 2013. The research relied upon secondary data obtained from the Nairobi Securities Exchange, and financial reports of the growth stock firms obtained from the Capital Markets Authority. High frequency data (monthly) was obtained for the bid prices of the stock. The period of study was the four year period between January 2008 and December 2013. The data collected was for 15 growth stock firms out of a possible 17, thus an overall success rate of 88.2%. The data was analyzed using descriptive analysis, propensity score matching and multiple regression analysis using SPSS. The results revealed that the DDM obtained from historical financial data of a growth stock had a weak positive significant correlation with actual stock returns (0.949). The study also found that market beta had a weak negative insignificant relationship with the DDM (-0.58). There is also a weak negative insignificant relationship between market beta and the actual stock return value of -0.001. The study recommends that in order for investors to make the best investment decisions regarding growth stocks in the NSE, the DDM model may be used in order to obtain a descriptive forecast of investment returns in such instruments, use of the CAPM model which heavily relies on market beta is however not advised. The study also recommends that there is also need to identify the growth stocks as prime investment ventures while taking caution to perform fundamental analysis of the company financials for the particular growth stocks.