Book-to-market ratio as a predictor of performance: a case study of companies listed at the Nairobi stock exchange (NSE)
Abstract
This research provides a test on the extent of predictive ability of book-to-market ratio
in the Kenyan stock market. The use of book-to-market ratio as forecasting variable is
examined using Nairobi Stock Exchange (NSE) data from 1996 to 2002.This study
mirrors studies done earlier by Fama and French (1992), Chan, Hamao and
Lakonishok (1996),Kothari, Shanken and Sloan (1997) among other researchers.
These studies yielded varying results; others are in agreement that these ratios do well
in forecasting stock returns while others conclude otherwise.
The data used in this research was collected from NSE's daily stock prices for the
period 1999 to 2002 from which the weekly returns for the listed firms were compiled
for the same period. Book-to-market values for the firms included in the sample were
also obtained from the NSE. This study focused on two portfolios of firms: those
which consistently have the highest book-to-market ratios over the period 1996
to 1998, and for those which consistently have the lowest book-to-market ratios over
the same period. The returns for the subsequent five years (1999 to 2002) are used to
evaluate the predictive power of the book to market. A qualitative analysis was
conducted in which various statistical tests were carried out. Chi square tests of
independence were conducted to test whether the book-to-market ratio has significant
explanatory power on the companies' future returns. Paired sample T-tests were used
to confirm whether there is a significant difference between the average returns for
the two portfolios while F-tests were conducted to test whether there is significant
difference between variance for the two samples.
The conclusions drawn from the research were that the portfolio for firms with low
book to market ratio made significantly higher returns than the portfolio for firms
with high book to market ratio. The portfolio with low book-to-market firms had an
average return of 2% between 1999 to 2002 while the portfolio with high book to
market ratio had average return of -10% during the study period. The book to market
ratio is found to have predictive ability, though returns of the two portfolios did not
differ significantly.
Citation
Masters of business administrationSponsorhip
University of NairobiPublisher
School of business,University of Nairobi