Relationship between profit warnings and stock returns of companies listed at the Nairobi Securities Exchange

Abstract

A profit warning is a public announcement saying that earnings for a reported period will not meet expectations (Bulkley & Herrerias, 2004). Firm managers tend to issue a profit warning when previous forecasts are believed to be too optimistic or unforeseen changes in economic or operational conditions have occurred. Stock markets need a flow of relevant and timely information to function efficiently. Most firms have the objective to actively inform the market and meet regulatory requirements. An example of a price sensitive event is a profit warning announcement. In Kenya, a lot of studies have been performed on NSE but a few studies have been done in Kenya. Muhoro (2004) and Ngigi (2006) found conflicting results on the application of value and growth styles at the NSE, this study therefore sought to establish the effect of profit earnings on stock returns applied by investors at NSE.The general objective of this study was to establish the relationship between profit warnings and stock returns of companies listed at the Nairobi Securities Exchange.In this study event study methodology was be applied. An event study design was chosen because it enabled the researcher to generalize the findings to a larger population. The population of interest in this study consisted of all the firms quoted at the Nairobi Securities Exchange (N.S.E). The study therefore picked the 10 companies issued profit warnings in the year 2012 for the period 2007 - 2012.Creswell (2002) defines data collection as means by which information is obtained from the selected subjects of an investigation. The study utilized secondary data for the period 2007 to 2012.The study found out that from year 2007-2012 Book value /market and earnings/profit was found out to be positively related to daily returns and consequently the average return over the five years. The result of research Study indicates that profit warning has impact on the stock return in NSE and the impact is negative and significant for the period of pre-warning and post-warning and on the day of actual announcement. The study recommends that profit warning being the pure information, unscheduled, and unexpected corporate announcement should be issued prior to the actual earnings announcement with the purpose of informing the market thus reducing the negative impact of the earnings surprise