Establishing the Efficiency of the NSE in Pricing Stocks Using the Dividend Valuation Model

Abstract

The purpose of this study was to establish the efficiency of the Nairobi Stock Exchange in pricing of listed stocks using the dividend valuation model. The real value of listed stocks was established at the commencement of financial year 2002 and was compared with the prevailing market price to determine the pricing efficiency of the NSE. The study examined stocks of seventeen companies. The study was quantitative in nature and used an experimental design approach to arrive at its findings. To support the quantitative analysis, the researcher held interviews with four experts from the stock market. The dividend valuation model presupposes that the value of a stock is equal to the present value of cash flows the stock is expected to earn over a given period of time. This means that the prime input of the model is cash flows. However, the study concluded that payment of dividends alone as proposed by the dividend model is not sufficient in determining the value of a security. There are other fundamental factors that affect its value. The findings from the study indicated that the stocks listed on the NSE at the beginning of financial year 2002 did not reflect their intrinsic value. This is an indication that the market was inefficient in its pricing mechanism of listed stocks. Such inefficiencies in pricing of stocks was largely due to the prevailing market environment. The study found out that the period prior to 2002 was characterized by unfavorable economic and political environment that affected the performance of the stock market.