An empirical analysis of the predictability of stock returns using the Price Earnings Ratio and the Price - to - book Ratio - a case study of the Nairobi Stock Exchannge

Abstract

The purpose of this study is to establish whether the Return Performance of the Stocks listed on the Nairobi Stock Exchange is predictable using the Price Earnings Ratio and the Price-to-Book Ratio. The two multiples have been attested to provide a cross sectional explanation according to studies done by scholars ~n both developed, and emerging markets. The study mimics the approach used by Basu, 1977 (P /E), and Lakonishok et al, 1993 (P /B). The results found for the P /E Ratio suggest the ratio has weak predictability power of the Returns on the NSE. This is as compared to other studies in developed markets that have evidenced strong evidence on the dominance of value investing over growth investing. The P /B Ratio is however found to have conflicting effects on the returns in the NSE compared to empirical literature such that the high P /B stock portfolio evidenced a higher return over the low P /B stock portfolio.