The relationship between accounting profitability and equity stock market prices of firms listed on the Nairobi Securities Exchange

Abstract

This study investigated the relationship between financial performance and share market prices of fourteen manufacturing and commercial firms listed on the Nairobi Securities Exchange (NSE). Financial performance was represented by return on equity (ROE), return on capital employed (ROCE), earnings per share (EPS) and the price-earnings (P/E) ratios, the independent or predictor variables, while market share price (SMP) was the dependent or response variable. An empirical causal quantitative survey design was applied, which involved collecting quantitative secondary data from annual audited company financial statements and from NSE-published market statistics over the five year period, 2011-2015. The study primarily applied correlation and regression techniques in data analysis. The study results indicated that the selected independent variables cannot be exclusively used to explain movements in market share prices of firms listed on the NSE. Correlation analysis revealed that: (i) no single predictor variable individually had a clear association pattern with the SMP; (ii) only three out of six possible combinations of two predictor variables demonstrated a consistent positive association pattern with the SMP, that is, ROCE and EPS, ROCE and P/E ratio, and EPS and P/E ratio; (iii) all possible four combinations of three predictor variables demonstrated a consistent positive association pattern with the SMP; while (iv) the combination of all four predictor variables demonstrated a consistent perfectly positive association pattern with the SMP. However, although the correlation analysis in this study provided some comforting results, these were quickly rebuffed by the results of regression analysis employed to assess the explanatory power of the independent variables over the dependent variable. The regression findings indicated that there was no single regression predictor model capable of accurately predicting or estimating the SMP of NSE firms under study. To this extent, the study results were largely inconclusive. Despite this inconclusiveness, the study results may be used as a source of additional evidence that listed share prices are influenced by many factors besides accounting profitability. Hence, technical predictions using only a number of selected accounting profitability variables could potentially give rise to incorrect or inconclusive results.