The effect of earnings yield on the stock returns of firms listed at the Nairobi Securities Exchange

Abstract

The use of valuation ratios as determinants of stock returns is widely being acknowledged. Seminal works present evidence of a return advantage on stocks with high earnings yield, book to market and dividend yield ratios. The objective of the study was to asses the the effect of the earnings yield ratio on the stock returns of companies listed at Nairobi Securities Exchange. It also aimed at reviewing the increasing body of theoretical and empirical studies that have endeavored to examine the range of magnitude and effects of predictability of stock returns using financial ratios. The study employed a causal research design. The target population was all the 65 firms listed at the NSE, the sample was represented by thirty firms listed at the Nairobi Security Exchange which had already listed at 2016 and was still listed at the end of 2019 and had issued dividends for at least three years of the study period. Secondary sources of data were employed. The unit period of analysis was annual, and data was collected for the period from 2016 to 2019. The period comprised of four years. The study applied correlation analysis and multiple linear regression equation with the technique of estimation being Ordinary Least Squares (OLS) so as to establish the the predictability of stock returns using financial ratios. The study findings were that only firm size is significantly correlated at the 5% significance level to stock returns. It has a negative association with stock returns. Further findings were that the model consisting of valuation ratios and the control variable, firm size, in unison influence stock returns and they can be utilized to significantly predict stock returns. Final findings were that only dividend yield and firms size had a statistically significant relationship with stock returns. Dividend yield has a significant positive effect on the stock returns while firm size has a significant negative effect. The study conclusion is that the Nairobi Securities Exchange is weak form efficient. Recommendations are that the Capital Markets Authority (CMA) can establish that the NSE is weak form efficient and focus on establishing the semi strong and strong form market efficiency. Further recommendations are that individual and institutional, and fund managers should focus making their investment decisions based on firm fundamentals and current public information because it has already been established that the NSE is weak form efficient. It is also recommended that firms trading in the NSE should strive to improve their fundamentals in order to enhance their market values because past information is already incorporated in the share prices.