The Relationship Between Price Earnings Ratio and Stock Return for Firms’ Quoted in Nairobi Securities Exchange

Abstract

The objective of the study is to assess the relationship between the P/E ratio and stock returns for firms quoted in Nairobi Securities Exchange (NSE). The study adopted a descriptive survey design. It involved a census survey of all the companies listed at the NSE during the years 2009-2013. These were subdivided into 10 subsets corresponding to the 10 sectors of the Exchange. Secondary data was obtained from the NSE Handbooks covering the period from January 2008 to December 2013 which provided 5-Year company financial performance summaries. The data collected was summarized into yearly weighted averages for the test variables for the NSE for the years 2009-2013. This summary data was then analyzed using descriptive statistics. Multivariate correlation and regression analyses were used to test the relationship between the price earnings ratio and the growth of earnings and stock prices. The study found that there existed insignificant relationship between the stock returns and P/E ratio but a positive relationship between the stock returns with ROE and MBV Research study further found different relationship when analysed per sector. Agriculture, Energy, insurance and Manufacturing recorded positive but moderate association between stock returns and P/E ratio. Banking, commercial and construction sector recorded negative but weak relationship hence contradicting the general observations. The study concluded that firms in different sectors behave differently according to the future expectation of the firm, the required rate of return and the industry it is in. The study also found that there is no significant relationship between stock returns and P/E ratio and conclude P/E ratio not a good indicator of future performance. The study concludes that there is strong relationship between ROE and MBV ,and MBV can be a better predictor of stock returns than the P/E ratio. Further research study is recommended to be undertaken in assessing whether the MBV can predict the stock returns in both short and long term for firms listed in NSE.