The Effect of Earnings Change on Stock Returns of Companies Listed at the Nairobi Securities Exchange

Abstract

Use of accounting information for valuation of equity is an area which has drawn the interest of different categories of individuals including investors who monitor companies accounting earnings and earnings changes patterns of the companies of their interest so as to make informed decisions in their investments. In the recent past this field made seminal contribution with the publication of Ball and Brown (1968) and also the works of Easton and Harris (1991) both explaining on the relevance of accounting information in explaining stock returns. Company’s earnings is a critical variable affecting the market value of equity share and once a company’s earnings increases, its equity value or equity return increases. Specifically, the study establishes the effect of earnings change on stock returns (capital gains) of companies listed at the Nairobi Securities Exchange as at December 2014.The study borrows many concepts from the works of Easton and Harris (1991).The study used a descriptive research design. The population of study was all 61 companies listed at the Nairobi Securities Exchange as at December 2014.The census approach was applied and only 51 companies whose complete secondary data was found were considered. The secondary data collected covered 2010 to 2014 period (5 years).The secondary data was obtained from the financial statement of the companies, from Nairobi Securities Handbook from 2009 to 2013 and monthly average stock prices were obtained from the Nairobi Securities Exchange and annualized to get annual average stock prices. A multivariate regression model was used to link the independent variables to the dependent variable. The study concludes that earnings change has an insignificant effect on stock returns (capital gains) of all companies listed at the NSE. The study also concludes that stock liquidity and firm size have a negative relationship with stock returns for all companies listed at the NSE. The study recommends that companies should concentrate on increasing its earnings but not its earnings changes because from this study, it is evident that it is earnings not earnings changes that play a role in prediction and explaining stock returns and this is in line with findings of Easton and Harris (1991) that earnings changes do not play any role in predicting and explaining stock returns. To the investors, potential investors, financial analysts and researchers, the study recommends that other factors other than earnings, stock liquidity and firm size should be considered and their effect on stock returns measured because the results of this study show that the above mentioned variables explain only a small percentage of the stock returns (capital gains).