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DECLARATION

This management research project is our original work and has not been submitted for the award

of a degree at any other university.

DANIEL KAMAU .....D33/34208/2010 SIGNATURE

FRANCIS GITARI......D33/39086/2010 SIGNATURE

MICHAEL MBULA D33/30284/2011 SIGNATURE

SAMUEL GATHOGAD33/33442/2011 SIGNATURE

WINNY MOGOTU..D33/30115/2011 SIGNATURE

This Management Research Project has been submitted for the examination with my approval as

the University supervisor

Signed Date

................................... ........................................

MR. Duncan Elly

Lecturer Department of Finance and Accounting

University of Nairobi


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ACKNOWLEDGMENTS

The path towards completion of this Management Research Project has been long and with many

challenges. There are many people who in one way or another greatly assisted in the process. I

wish to convey our heartfelt gratitude to all of them.

Special thanks to our supervisor Mr. Duncan Elly whose guidance facilitated the realisation of

this work. Their invaluable critique and input in terms of materials and discussions opened our

minds to the quality of academic writing.

To Justus Agoti of Capital Markets Authority and Joseph Mwenda an analyst at Nairobi

Securities Exchange who took their valuable time to provide the necessary information for the

study, we would want to thank them very sincerely for freely sharing knowledge and ideas on the

subject under study. Their input was critical in establishing the findings is this study in whichconclusions are made and therefore bringing it to an end.


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DEDICATION

To Samuel Mubeas father David Gathoga, mother, Janet Wambui, for their unwavering

support, financially and encouragement through the academic progression. Through their

support, I was able to accomplish the research project.

To Francis Muchangis brother, Mr.John Mugo Gitari who supported me financially and

emotionally.

To Winny Mogotus parents Mr. Nelson Nyamari and Mrs. Rebecca Nyamari for their

understanding, financial and moral support through the process of writing this paper.

To Eunice Michaels father, Mr. Michael Maluki for their unconditional love, moral and

financial support during this time.

To Daniel Mwangis parents, Mr and Mrs. Kamau and uncle, James.K.Warui, who were a great

source of love, encouragement and wisdom. They have given me the drive and discipline to

tackle any task with enthusiasm and determination. Without their love and support this project

would not have been made possible.


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ABBREVIATIONS

CAPM Capital Asset Pricing Method

CDSC Central Depository and Settlement Corporation

CMA Capital Markets Authority

EABL East African Breweries Limited

EMH Efficient Market Hypothesis

H1 Alternative Hypothesis

HO Null Hypothesis

KQ Kenya airways

NASI NSE-All share Index

NSE Nairobi Securities Exchange

NYSE New York Stock Exchange

PAD Post-Announcement Drift

TOTAL Total Kenya Company Limited


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TABLE OF CONTENTS

DECLARATION ............................................................................................................................. i

ACKNOWLEDGMENTS .............................................................................................................. ii

DEDICATION ............................................................................................................................... iii

ABSTRACT ................................................................................................................................... iv

ABBREVIATIONS ........................................................................................................................ v

CHAPTER ONE: INTRODUCTION ............................................................................................. 1

1.1Background of the study ........................................................................................................ 1

1.1.1Profit Warnings Announcement ...................................................................................... 4

1.1.2 Classification Of Profit Warnings. ................................................................................. 5

1.1.3 An Overview of Nairobi Securities Exchange ............................................................... 5

1.2 Statement of the Problem ...................................................................................................... 7

1.3 Objectives of the Study ......................................................................................................... 7

1.4 Research Questions ............................................................................................................... 8

1.5 Significance of the study ....................................................................................................... 8

CHAPTER TWO: LITERATURE REVIEW ............................................................................... 10

2.1 Introduction ......................................................................................................................... 10

2.2 Profit warnings .................................................................................................................... 10

2.2 Theoretical Framework of the study ................................................................................... 11

2.2.1 Efficient market hypothesis .......................................................................................... 11

2.2.2 Random walk theory ..................................................................................................... 14

2.2.3 Post-announcement drift ............................................................................................... 15

2.3 Empirical studies ................................................................................................................. 17

2.3.1 Profit warnings ............................................................................................................. 17


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2.3.2 Insider trades around profit warnings ........................................................................... 20

2.4 Conclusions ......................................................................................................................... 21

CHAPTER THREE: RESEARCH METHODOLOGY ............................................................... 23

3.1 Introduction ......................................................................................................................... 23

3.2 Research Design .................................................................................................................. 23

3.3 Population............................................................................................................................ 23

3.4 Sample size .......................................................................................................................... 24

3.5 Data collection..................................................................................................................... 24

3.6 Data analysis ....................................................................................................................... 25

3.6.1 Event date specification . .25

3.6.2 Measuring daily returns ...26

3.6.3 Measuring the cumulative returns ...26

CHAPTER FOUR: DATA ANALYSIS, FINDINGS AND INTERPRETATION ..................... 27

4.1 Introduction ......................................................................................................................... 27

4.2 Findings ............................................................................................................................... 27

CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS..................... 42

5.1 Summary and conclusion of findings .................................................................................. 42

5.2 Policy recommendations ..................................................................................................... 43

5.3 Limitations for the study ..................................................................................................... 43

5.4 Suggestions for further study .............................................................................................. 44

References ..................................................................................................................................... 45

APPENDICES .............................................................................................................................. 49

APPENDIX 1 LIST OF COMPANIES AND DATES OF PROFIT WARNING

ANNOUNCEMENT ................................................................................................................. 49

APPENDIX 2 EAST AFRICAN BREWERIES LIMITED .................................................... 50


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APPENDIX 3 KENYA AIRWAYS .................................................................................. 51

APPENDIX 4 CMC HOLDING LIMITED .................................................................. 52

APPENDIX 5 TOTAL KENYA LIMITED........................................................................ 53

APPENDIX 6 SAMEER AFRICA LIMITED ...................................................................... 54

APPENDIX 7 SASINI LIMITED ......................................................................................... 55

APPENDIX 8 ACCESS KENYA GROUP LIMITED ........................................................... 56

APPENDIX 9 EVEREADY EAST AFRICA LIMITED ....................................................... 57

APPENDIX 10 EAST AFRICAN CABLES LIMITED ...................................................... 58

APPENDIX 11 KAKUZI LIMITED ...................................................................................... 59

APPENDIX 12 LONGHORN KENYA LIMITED ................................................................ 60

APPENDIX 13 NATIONAL BANK OF KENYA .................................................................. 61

APPENDIX 14 MUMIAS SUGAR COMPANY LIMITED ................................................ 62

APPENDIX 15 CFC STANBIC ............................................................................................ 63

APPENDIX 16 UCHUMI SUPER MARKET ........................................................................ 64


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CHAPTER ONE: INTRODUCTION

1.1 Background of the study

Investors who participate in the capital markets expect that their investment will bring a high

return in the future which will compensate for the related risks and expenses. Thus, they evaluate

the investment; they calculate the benefits and the costs at the same time, which is the net present

value calculation. However, firms that sells their shares to investors will receive more funds if

stock prices are high, so that these firms can grow and produce values or assets in the economy

(Penman, 2009, Bodies, Kane, & Marcus, 2009).The stock prices play a signalling role in the

distribution of the economic resources from investors to firms. (Fama, 1970) From a broader

perspective, in order to efficiently allocate the funds in society, it is important that the stockmarket valuation process and prices is correct (Arnold, 2008). The incorrect value of the stock

today or tomorrow can be harmful in ten or twenty years and therefore impact the economy and

society in terms of uneven allocation of resources.

Todays and tomorrows lower or higher than true value of the stock can beharmful in ten or

twenty years economy and society in terms of asset allocation thusvalue creation. (Arnold,

2008, Shiller, 2000).In allocating the capital effectively and productively, the transparency

should exist in the market so that investors will make a rational, well-informed decision. If a firm

misleads the investors about the future prospect of the firm it will be difficult for investors to

make such decisions (Bodie et al., 2009). Therefore, information disclosures from the firm are

essential in order to make a correct decision in valuing a stock, thus allocating capital optimally.

Moreover, according to Fama (1970), if the market is efficient, all available information should

reflect in the security price and the security price will move as soon as the new information

comes to the market. In order to maintain transparency, companies disclose different types of

information to communicate with the public, such as, the key operating performance indicators,

borrowing and capital structure, and dividend payment. In this way, the investors will know the

companys financial condition.

The companys earnings are a main determinant of the stock price, because the earnings indicate

the operational result of the firm and its future success. Therefore, companies are required to


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inform the investors about its performance. Earnings are presented to the public on a half yearly

or yearly basis. In Kenya for example, companies are supposed to report 3 months after the end

of each accounting period .If earnings reported are above or below the analysts earnings

estimates, it will be a surprise to the market. Consequently, if this earnings surprise is positive

the share price will usually increase, or if it is negative the share price will

decrease. In order to avoid such drastic changes in the stock prices and to reduce the magnitude

of the market reaction, companies warn the public regarding the unexpected level of earnings.

The content of the warning is that the company earnings will not meet the market expectations.

This announcement is called the profit warning. It is an attempt to communicate the earnings

disappointment from the companies to the investment community. As the information disclosure,

the profit warning improves transparency; this may result in re-evaluation of the stock price thus

enabling financial market participants to make the right choice. According to Clare (2001), the

profit warning is an adverse outlook for the companys future earnings and profitability through

the press, which is market-relevant information and might result in revising profitability

expectations from financial agents. Holland & Stoner (1996) claimed that the profit warning is

one of the events that make the companies reveal price-sensitive information to the market. The

1994 Criminal Justice Act defined price-sensitive information as information that can result in a

significant effect on the price of securities if the public receives it. Furthermore, Holland&

Stoner (1996) pointed out that the significant effect of information is related to the companys

main financial performance aspects such as future earnings and profitability, borrowings and

capital structure.

The disclosure of the profit warning will influence brokers and analysts evaluation of company.

Analysts will revise the previous earnings expectation based on the companys current operating

conditions. Then the analysts might warn the companys shareholders and potential shareholders.

The investors are concerned about the companys profitability and competitive power in the

long-term after the company releases the profit warning, which might cause a negative market

reaction. Thus the companys value will decrease, which may result in the increase of the cost of

capital, lowering in the companys rating. Consequently, the companys circumstances become

worse. When the company fails to meet the new expected earnings, the similar result occurs. It


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becomes a vicious circle. The disadvantage of keeping such transparency is that the company

reveals their bad condition to the investors and the competitors. That will impact the companys

reputation after the profit warning.

The profit warning disclosure results in a negative market response to warning companies.

However, from the long-term perspective, it is helpful for allocating the capital efficiently,

reducing the information asymmetry, protecting the interests of the investors, building the

investors confidence in the market and correcting the market expectation regarding overvalued

firms. If there is regulation to disclose the profit warning, there will be less information

asymmetry problem. Kasznik& Lev (1995) studied the regulated firms like banks and utility

providers give reports to regulators, which indirectly inform the public. From these reports, the

public will constantly obtain more detailed and timely operating information than they can obtain

from the quarterly financial reports, thus information asymmetry is reduced.

Moreover, the impact of the profit warning is different based on firm specific factors, such as

size. Kasznik& Lev (1995), Bulkley & Herrerias (2004), Jackson& Madura (2003), Collett

(2004), Francoeur, Labelle, & Martinez (2008), and Elayan&Pukthuanthong (2009) compared

the different effects for large versus small firms following the profit warning. They divided the

companies into large or small according to the total assets. All of them found that small firms

were beaten more than the large firms. The market reactions following the profit warning is a

complicated issue.

Based on the Efficient Market Hypothesis (Fama, 1970), the market will respond to the new

information rapidly. The profit warning will result in the movement of the stock prices, as soon

as, the company releases it to the market. After the adjustment of the market, the security price

can reflect the all available information in the market. No company will be overvalued or

undervalued. However, in practice, the investors over-react or under-react to the warning

announcement, which is associated with the investors behaviour and the timing of the

information.

If the profit warning causes a negative market reaction and it reveals the companys bad

condition to the market, why are the companies still willing to disclose it? There are several main


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reasons. The first reason is, to prevent a significant decrease in the stock price. The management

tries to prepare the investors for the earnings disappointment prior to the real earnings

announcements and reduce the magnitude of the reactions. Therefore, they avoid the dramatic

volatility of the companys value. The second reason is to avert the legal liability and lawsuit

cost. The company will face legal consequences if it fails to disclose the bad news. This might

result in the loss of investment value for the stock holders.

The third reason is to maintain the reputation in the market and sustain good communication

with the public. The fourth reason is the cost of capital. If the company fails to disclose bad

news, the investors might lose confidence in it. That will result in declining share prices, falling

credit rating and liquidity problems, and ultimately in an increase in the cost of capital. The

reason is the regulation. In some countries, it is compulsory for companies to issue the profit

warning if the companys financial condition changes enough to affect the market value of the

company. The violation of this regulation will result in legal consequences. The above

introduction demonstrates that the profit warning is a complicated issue.The effects of the profit

warning on the stock price and the companys value triggers our interest and attention to do

research in this academic and practical area.

1.1.1Profit Warnings Announcement

The profit warning is an announcement released by companies and it reveals that the earnings

will be lower than expected. Moreover, the earnings drop can be expressed in other terms, like

net profits, sales, earnings before interest and taxes, and earnings per share

(Elayan&Pukthuanthong, 2009).In the definition of profit warning, the earnings expectation is

used to compare with the incoming earnings. If the incoming earnings will not meet the expected

earnings, the company will publish the warning announcement to the market by press,

conference, or on the company website.

Business daily newspaper from the Nation media group (December 2nd

,2012) posted that 10

companies had issued profit warnings unlike the previous year where only 2 companies had

made such announcements. Examples of such companies include; Uchumi Supermarket, Kenya

Airways, Total Kenya, Sasini, CMC holdings, Eveready Kenya, Sameer Africa, East African

Breweries limited, East Africa cables, East Africa Portland Cement company, Access Kenya,


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Mumias Sugar Company, CFC Bank, National Bank, Agricultural firm Kakuzi and Longhorn

Kenya. Companies and their advisers should be aware of the market expectations built into the

companys share price. That is, earnings expectations affect the companys stock prices. The

earnings estimates of companies are important for investors in the security market because

investors assess the companys future income and profitability based on earnings estimates.

Therefore, it impacts investors decision of purchasing or selling thestocks.

1.1.2 Classification Of Profit Warnings.

The profit warning is classified into two types: quantitative and qualitative. Literally, the

quantitative warning is the warning announcement involved in the numbers, which provides the

exact number of earnings estimate or interval. On the other hand, the qualitative one states or

indicates that earnings will fall below the current expectations without offering a specific

estimation of the new earnings. For example, firms prefer to employ these phrases to express

qualitative warnings; unlikely to reach estimates and significantly below estimate

Bulkley & Herrerias (2004,). Skinner (1994) also wrote the management adopted quantitative

announcement such as point, range and lower-bound forecasts and qualitative one like

earnings will be down orearnings will be disappointing to disclose bad earnings prior to the

real earnings announcement. He called this disclosure the earning-related disclosure. Two

types of profit warnings offer the opportunity to test not only whether the market under reacts to

news ,but also whether the scale of any under-reaction is related to the quality of the information

released. This has implications for how under-reaction might be explained. This research looks at

the listed companies at the Nairobi Securities Exchange with an aim of investigating the effects

of profit warnings announcement on the share prices.

1.1.3 An Overview of Nairobi Securities ExchangeNSE is the principle securities exchange in Kenya to date and it began in the early 1920s. Like

many others emerging markets, the NSE suffers from the lack of liquidity in the market. Foreign

investment on NSE and foreign ownership of companies is by application. Foreign investment in

the local subsidiaries of foreign-controlled companies is banned so as to encourage input in to

Kenyan companies.


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The Kenyan government has made several reforms aimed at attracting foreign investment via the

NSE. In January 1995, the exchange was opened to foreign investors for the first time, but with a

maximum limit of 20% shareholding for institutions and 2.5% for individuals. The ceiling on the

foreign investment has recently been increased to 40% for institutions and 5% for individuals,

but fewer than 20 of the 58 listed companies were available to foreigners.

However, the Kenyan government since 1995 has opened trade in the NSE and gilts to foreign

portfolio investors; removed exchange controls and introduced a favourable tax regime with non-

residents paying a 10% withholding tax on dividends (locals 5%) but no capital gains, stamp

duty or value added tax.

The NSE was registered under the companies act in 1991 and phased out the Call over trading

system in favour of the floor-based Open-outcry system. Computerization has also been

enhanced with installation of automated trading system. A wide area network enables broker

undertake transactions from their offices without necessarily having to go to the floor of the

NSE. Trading takes place on Mondays through Fridays between 9.30am to 3.00pm.

The Central Depository and Settlement Corporation (CDSC) was established in 2002. The CDSC

is the legal entity that owns the automated clearing, depository, registry system (CDS) and

settlement. The NSE regulations and rules set out the operational and procedural rules for the

purpose of ensuring orderliness, efficiency of the market in the initial admission of securities to

the official list of the exchange, the listing of additional shares, and the continuing listing

obligations in compliance with the Capital Markets Act and the regulations and guidelines issued

there-under. Two popularly indices are used to measure performance. The NSE 20 share index

has been used since 1964 and measure of performance of 20 blue chip companies with strong

fundamentals and which have consistently returned positive financial results.

The NSE all-share index (NASI) was introduced in 2008 as an alternative index. Its measures are

on overall indicator of market performance. The index incorporates all traded shares in the day

and therefore its focus is on overall market capitalization rather than the price movement of

selected counters

A third index is the AIG 27 share index that compares price movements of 27 companies

identified as relatively stable. The operation of the index compares to the NSE 20 share index.


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1.4 Research Questions

The profit warning is considered as bad news by the market because it reveals companys

adverse future profitability and competitiveness. Therefore, it results in significant negative

returns in the stock markets. According to previous empirical researches on Efficient Market

Hypothesis (EMH), some African countries stock markets are efficient and the security prices

are followed by a random walk. Therefore, based on the concept of EMH, the stock price will

fluctuate immediately after the information of profit warning is disclosed. Then the information

provided with the profit warning will be reflected in the stock price. Thus, the question we seek

to answer is: what are the effects of profit warnings announcement on share price? To analyse

the problem, the study will test the following two hypotheses;

- HO: There is no relationship between share prices and profit warnings announcements.- H1: There is a relationship between share prices and profit warnings announcement

1.5 Significance of the study

Our research will give suggestions to the following: Companies managers, investors,

academicians, financial analysts and fund managers.

Companys management; the profit warning disclosure reduces the impact of surprise at the

time of the real earnings announcement, because the profit warning prepares the market for thebad news. Since the profit warning may result in negative stock returns, the management can

minimize the effect through selecting different types of warning announcements, such as

quantitative or qualitative ones. At the same time, the companies delivering the announcement

regarding the companies condition are being more transparent to the public. Not only do the

companies avoid a law suit, they might gain the trust from the public by issuing the profit

warning.

Investors; the investors can consider the profit warning rationally and make a wise investment

strategy. Investors assess the companys value and the future profitability based on the analysis

of the companys financial statements and industry environment. By having knowledge about the

profit warning and its impact, investors might re-assess their investment decisions thus avoid

overreaction or under-reaction regarding the event of profit warning. Furthermore, some


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investors might benefit from the significant negative market reaction and take a speculative

position right after the disclosure of the profit warning.

Financial analysts; By studying the findings of this research, financial analysts will be able to

obtain accurate information on the effect of profit warning announcement on share prices, adding

to the information they have and hence they will be in a better position to advice investors on

which companies to invest in.

Academicians; This study will add to the body of knowledge in the discipline of finance. The

findings may also motivate other researchers to do further research in other countries, undertake

the same research in subsequent periods or explore the topic further.

Fund managers; The findings of this study will assist fund managers in making informed

decisions on portfolio mix, by making use on information on effect of profit warning

announcements on share prices, fund managers can decide whether to invest in a portfolio with

stocks that pay consistent dividends or not, and how to hedge their portfolio returns.


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CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction

This study draws basis from several research areas. First, it examines theoretical foundations on

the Efficient market hypothesis (Fama 1970, Augustine K S 2011), the Random walk theory

(Odiwuor W 2002,Kendall 1953 , Cowles 1937) and Post-announcement drift theory(Bernad and

Thomas 1989,1990, Ball 1992). Literature that documents earlier empirical studies on profit

warning announcement is also discussed .Research work on insider trades around profit warning

is also revealed. Finally, prior empirical research focusing on related areas of earnings

announcements and anomalies at the NSE are revealed. Major conclusions from the literature

review, identification of research gaps and a summary of how the study differs from the

reviewed studies is made.

2.2 Profit warnings

Profit warning is a warning declaration issued by a listed company toinvestors through astock

exchange.It warns that theprofit of the company in the comingquarter will obviouslydecline or

even have aloss compared with that of the same quarter of previous year. Investors should be

aware of the possible loss when buying or selling its stock. Sometimes, profit warning is

considered to be a neutral term and it refers to "estimated results improvement".

Some companies may issue "profit warning" to inform that their expected profit will obviously

increase in the coming quarter. A profit warning is usually done two or more weeks before an

earnings announcement. Companies do this to soften the blow to investors. This gives the

investors and the market more time to adjust accordingly before the public release, ideally taking

some of the sting out of the expected price adjustment. If no profit warning is released, the

earnings announcement is called a negative earnings surprise.

Profit warnings are part of the large, fluid world ofearningsguidance,whereby the management

of publicly traded companies issue estimates about what they expect earnings to be for the

coming quarter. The guidance is based on management's experience, calculations, and outlook.

Management earnings estimates significantly influence theanalysts covering thestock,because
http://en.wikipedia.org/wiki/Listed_companyhttp://en.wikipedia.org/wiki/Investorshttp://en.wikipedia.org/wiki/Stock_exchangehttp://en.wikipedia.org/wiki/Stock_exchangehttp://en.wikipedia.org/wiki/Profit_%28accounting%29http://en.wikipedia.org/wiki/Fiscal_yearhttp://en.wikipedia.org/wiki/Declinehttp://en.wikipedia.org/wiki/Income_statementhttp://en.wikipedia.org/wiki/Income_statementhttp://en.wikipedia.org/wiki/Stockhttp://www.investinganswers.com/financial-dictionary/financial-statement-analysis/earnings-1514http://www.investinganswers.com/financial-dictionary/businesses-corporations/guidance-5273http://www.investinganswers.com/financial-dictionary/stock-market/issue-5068http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/analyst-5331http://www.investinganswers.com/financial-dictionary/businesses-corporations/stock-5150http://www.investinganswers.com/financial-dictionary/businesses-corporations/stock-5150http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/analyst-5331http://www.investinganswers.com/financial-dictionary/stock-market/issue-5068http://www.investinganswers.com/financial-dictionary/businesses-corporations/guidance-5273http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/earnings-1514http://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Income_statementhttp://en.wikipedia.org/wiki/Income_statementhttp://en.wikipedia.org/wiki/Declinehttp://en.wikipedia.org/wiki/Fiscal_yearhttp://en.wikipedia.org/wiki/Profit_%28accounting%29http://en.wikipedia.org/wiki/Stock_exchangehttp://en.wikipedia.org/wiki/Stock_exchangehttp://en.wikipedia.org/wiki/Investorshttp://en.wikipedia.org/wiki/Listed_company


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the analysts incorporate these estimates into their own research and earnings forecasts for their

clients.

Some companies do not giveguidance,and thus do notissueprofit warnings. The choice to not

provide guidance is usually made to reduce legal liability in the event that management's

estimates are wrong. Someanalysts claim that companies that do not offer any guidance often

receive a "break" on stock price changes when these companies miss earnings, because the

market is aware that the company's management has given the analysts (and their resulting

estimates) no input.

2.2 Theoretical Framework of the study

2.2.1 Efficient market hypothesis

The origin of efficient markets hypothesis dates back to 1965 when Samuelson1965 published

his proof that properly anticipated prices fluctuate randomly. The term efficient markets was first

introduced in economics literature by EugeneFama (1970).The study also known as the efficient

market theory asserts that financial markets are informationally efficient or that prices on

traded assets e.g. stocks, bonds or property already reflect known information. It supports that

prices of the financial assets traded such as stocks, bond, derivatives, in a market, reflect and

incorporate all the available known and relevant information. In this respect these prices are

unbiased and reflect the aggregate beliefs of all investors about future prospects of firms, market

sectors and the market as a whole.

Accordingly its thus impossible to consistently outperform the market through expert stock

selection or market timing by using any information that the market already knows except

through luck, and that the only way an investor can possibly obtain higher returns is by

purchasing riskier investments. According to EMH stocks always trade at their fair value on

stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell

stocks for inflated prices. Information or news in EMH is anything that may affect prices that is

unknowable in the present and thus appears randomly in the future.
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Market efficiency means security prices adjust rapidly and correctly to the arrival of new

information and thus current security prices reflect all information about the security, and there is

no reason to believe that the current prices is too low or too high. In an efficient market,

information is widely and cheaply available to investors and that all relevant and attainable

information is already reflected in the security prices. EMHs advocates argue that although

inefficiencies may exist, they are relatively small and not common. Fama classified the market

efficiency in to three forms of market efficiency on the basis of the information:

Weak form: Stock price will reflect historical information of past prices and returns. Market

prices reflect all historical price information and are only changed due to random walk i.e. new

information reaching the market. The information subset is merely historical price or return

sequences. Consequently, the price of a financial asset on any given day can be predicted by the

previous days price plus the expected return of the asset and an unpredictable random factor.

Hence, technical analysis is of no use. Any analysis based on previously known facts cannot

yield abnormal returns, since market prices already reflect all historical information available

(Fama 1970, 1991).

Semi strong form: The semi strong level of market efficiency states that the price of a financial

asset in addition to all the historical prices also reflects all available public information (1970,

1991) Public information consists of a combination of macro and company specific data. In this

market, prices of financial assets already reflect all available information. Hence fundamental

analysis is of no use. The only way to achieve abnormal returns is to use inside information

(Arnold, 2005).

Strong form: Stock prices fully reflect all information including public and private works

known to any market participants .All information is reflected in market prices including inside

information. In this case, no investor can have an information advantage. Since the strong level

of market efficiency reflects all information, no information asymmetry exists. Thus, not even

inside information can be used to achieve abnormal returns (Arnold, 2005).


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2.2.1.1 Anomalies of efficient market hypothesis

The Efficient Market Hypothesis became controversial especially after the detection of certain

anomalies in the capital markets. Some of the main anomalies that have been identified are as

follows.

Small size effect: Banz (1981) published one of the earliest articles on the small-firm effect

which is also known as the size-effect. His analysis of the 1936-1975 periods reveals that

excess returns would have been earned by holding stocks of low capitalization companies.

Supporting evidence is provided by Reinganum (1981) who reports that the risk adjusted annual

return of small firms were greater than 20%. If the market were efficient, one would expect the

prices of stocks of these companies to go up to a level where the risk adjusted to future investors

would be normal. But that did not happen.

January effect: Rozeff and Kinney (1976) were the first to document evidence higher mean

returns in January as compared to other months. Using the NYSE stocks for the period 1904-

1974, they found that the average return for the month of January was 3.48% as compared to

only 0.42 percent for the other months

The weekend effect (Monday effect): French (1980) analyses daily returns of stocks for the

period 1953-1977 and finds that there is a tendency for returns to be negative on Mondays

whereas they are positive on the other days of the week. He notes that these negatives returns are

caused only by the weekend effect and not by a general closed-market effect. A trading

strategy, which would be profitable in this case, would be to buy stocks on Monday and sell then

on Friday.

Over/under reaction of stock prices to earnings announcement: There is substantial

documented evidence on both over and under-reaction to earnings announcement. DeBondt and

Thaler (1985, 1987) present evidence that is consistent with stock prices overreacting to current

changes in earnings. They report positive (negative) estimated abnormal stock returns for

portfolios that previously generated inferior (superior) stock price and earning performance. This

could be construed as the prior period stock price behaviour overreacting to earnings

development (Bernard, 1993).


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Such interpretation has been challenged by Zarowin (1989) but is supported by DeBondt and

Thaler (1990). Bernard (1993) provides evidence that is consistent with the initial reaction being

too small, and being completed over a period of at least six months. Ou and Penman (1989) also

argue that the market underutilizes financial statement information. Bernard (1993) further notes

that such anomalies are not due to research design flaws, inappropriate adjustment for risk, or

transaction costs. Thus, the evidence suggests that information is not impounded in prices

instantaneously as EMH would predict.

2.2.2 Random walk theory

The random walk theory argues that the share price movement are independent of one another

and unrelated. This happens in an efficient market where the current prices of the securities

represent unbiased estimates of their intrinsic values. The theory holds that the price move in a

random manner hence it is not possible to predict future prices. The price movement, whether up

or down, occurs as a result of new information and since investors cannot predict the kind of new

information(whether good or bad), it is not possible to predict future price movement. The

random walk theory is closely related to the EMH.

When Kendall (1953) studied 22 UK stock commodity price series, he concluded that in a series

of price which are observed at fairly close intervals the random changes from one term to the

next are so large as to swamp any systematic effect which may be present. The data behaves

almost like wandering series.

This empirical observation came to be called the Random Walk Model. If the prices wander

randomly, then this poses a major challenge to market analysts who try to predict the future path

of security prices; Drawing on Kendalls work and earlier research by Cowles (1937)

demonstrated that a time series generated from a sequence of random numbers was not

distinguishable from a record of US stock prices, the raw material used by market technicians to

predict future price levels.

Despite the emerging evidence on the randomness of stock prices changes, there were occasional

instances of anomalous price behaviour, where certain series appeared to follow predictable


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paths. This includes a subset of the stock and commodity price series examined by (Owler 1937)

and (Kendall 1953).

According to Fisher and Jordan (1979), the random walk theory is a special case of a more

general EMH.

2.2.3 Post-announcement drift

On a broader level, profit warnings are related to earning announcements containing surprises.

The only difference is that earnings announcements have a predetermined date and profit

warnings are unexpected. According to the semi-strong efficient market hypothesis (Fama, 1970)

stock prices react quickly in an unbiased matter to new public information. Over the years many

researchers studied the market reaction in response to earnings information. This led to the

discovery of one of the most robust anomaly in finance and accounting literature: post-earnings-

announcement drift (hereafter, PAD).

PAD is the phenomenon that stock returns continue to drift downward (upward) following a

negative (positive) earnings signal reported at the scheduled earnings announcement date. In a

seminar work, Ball and Brown (1968) were the first one who provided evidence of the PAD

phenomenon after studying annual earnings announcements in the US for the period 1946-1966.

Since then, many researchers found supporting evidence for this phenomenon using more recent

data and for various markets outside the US.

After the discovery of this anomaly many researchers tried to explain the phenomenon and up to

now no consensus has been reached regarding the source of the drift. The explanations include:

methodological issues, misspecification of normal returns and market under reaction. Bernard

and Thomas (1989, 1990) and Ball (1992) show that PAD cannot be attributed to research design

flaws such as: survivorship bias, hindsight bias arising from restatements of CRSP data or

measurement errors in CRSP returns resulting from imbalances in quoting bid or ask prices. In

addition, Bernard and Thomas (1989) studied whether PAD is the result of CAPM

misspecifications. They show that neither factors from the arbitrage-pricing theory nor beta

fluctuations around earnings announcements are able to explain the drift. Fama (1998) failed to

explain the phenomenon using a three-factor model (Fama& French, 1996), which extends the

CAPM model with two additional factors; the difference between the return on a portfolio of


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small and large stocks and the difference between a portfolios of high and low book-to-market

stocks.

The third explanation is that markets under react to earnings announcement, and is considered

by many researchers as the predominant explanation. Market under-reaction is the phenomenon

that new information is incorporated into stock prices with a delay resulting in a post-event drift.

However the cause of this market under-reaction remains unclear. According to Bernard and

Thomas (1990) market under reaction is a consequence of investors who wrongly believe

earnings follow a seasonal random walk process, i.e. future earnings equal corresponding prior

period earnings. This argument is based on the finding that a relatively large part of the drift

occurs around the next earnings announcement, suggesting the market tends to be surprised.

The seasonal random walk model is based on year-to-year comparisons financial media use

whenever listed firms publish their earnings information. As a result investors neglect the

autocorrelation of in-between quarterly earnings announcements and end up with a nave

expectation model that underestimates the implications of current earnings on future earnings.

On the other hand, Ball and Bartov (1996) present a more sophisticated investor who doesnt

base his expectations on a simple seasonal random walk and acknowledges the existence of

autocorrelations in unexpected earnings. It is the magnitude of the autocorrelation that is

underestimated by the market (by approximately 50%) and this in turn causes market under

reaction.

Another paper by Chordia and Shivakumar (2005) argues that contrary to bond investors, stock

investors underestimate the implication of inflation on future earnings, i.e. the stock market

under reacts to inflation information. This can partially explain the underestimation of the

magnitude of serial correlation documented by Ball and Bartov (1996).

More recently, several researchers moved towards incorporating behavioural finance as a

possible explanation for market under reaction. Behavioral finance assumes investors form

biases which might influences their judgment of information, resulting in less than fully rational

decisions. For instance, Daniel, Hirshleifer and Subrahmanyam (1998) develop a model of

investor behaviours based on two well-known psychological findings: overconfidence and self-

attribution bias. Overconfidence means investors overestimate the precision of private


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information signals. Biased self-attribution means investors overweight information that

confirms prior beliefs and underweight information that contradicts prior beliefs.

Consequently the model predicts that investors under react to public information. In a

contemporaneous paper Barberis, Shleifer and Vishny (1998) develop a model of investor

behaviour where market under reaction is the result of investors suffering from a conservatism

bias, the phenomenon that people only gradually adjust their beliefs to new information

(Edwards, 1968). As a consequence investors assume earnings follow a mean-reverting process

and underweight the information content of earnings announcements.

2.3 Empirical studies

2.3.1 Profit warnings

According to Elayan (2009), profit warnings are defined as earnings forecasts made by

management that warns of an expected earnings shortfall in relation to a relevant standard

.Management profit warnings may be released at any time prior to the announcement of actual

earnings report. The earnings shortfalls may be in terms of net profits, sales, earnings before

interest and taxes (EBIT), and earnings per share (EPS), etc.

Previous research has shown that the timing of management disclosures affect the revision of

subsequent analyst forecasts. Baginski and Hanssell (1990), show that analysts follow

management forecasts more closely in the fourth quartet. These issues suggest that the

differential timing of profit warnings have several implications for shareholder reaction.

In their investigation of managements discretionary before a large earnings disappointment,

Kasznik and Lev (1995), reported that the likelihood of warning increased with firm size, the

presence of an earlier forecast and membership in the high technology industry. Warnings were

also found to be associated with permanent earnings decreases. Helbok and Walkers (2003)findings in the less litigious UK environment where firms reported less frequently indicated

that profit warnings are value-relevant events with firms experiencing an average 20% decline

in share price in response to them. They also found profit warnings to signal a permanent

earnings decline. Firms did not appear to be reprimanded for their honesty when issuing profit

warnings where Tucker (2005), found that while in the short-term , their returns were more


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negative relative to firms with no warnings ,their long run returns were more positive. In terms of

long term consequences, Bulkley, Harris and Herreiras (2002) also found strong reversal one to

two years after the warnings, mainly in small firms

Mohamed (2010) studied the effect of earning announcements on the stock prices of companies

listed at the NSE. He studied 45 companies declaring earnings between January 2004 and

December 2008. The study found that earning announcement may carry some information for the

market and stock prices may be adjusted accordingly. The findings showed that statistically

significant negative abnormal returns were observed in the post and pre-earnings announcements

period.

Onyango, (2004) in his study covered 16 companies out of a population of 48 listed companies at

NSE, discovering the period 1998-2003. The study concluded that the earnings announcement

contain relevant information which is fully impounded the stock prices prior to or almost

instantaneously at the time of announcement. Secondary evidence resulting from the study

showed that NSE shows the presence of semi strong model of EMH. He suggested further

research on information content to support his conclusion.

Jackson and Madura (2003) reported a strong negative reaction, starting five days before the

announcement with the reaction complete within five days after the warning .While there was no

overreaction to the announcement, small firms reacted more negatively in the announcement and

post-announcement periods while in the pre-announcement period, more negative reactions were

observed in large firms. Collet (2004), studied the accounting detail provided in profit warnings,

in particular information on sales growth and operating margin changes and found only 35% and

42% of firms issuing warnings and upgrades respective provided quantitative information

Insider trading activity around profit warnings has not yet been studied though similarities exists

with studies around financial distress (Seyhun and Bradley, 1197), breaks in earnings trends (Ke,

Huddart and Petroni, 2003) and around management earnings forecasts (Noe, 1999; Cheng and

Lo, 2006). Seyhun and Bradley (1997) reported insider selling beginning five years before a

bankruptcy filing, escalating to the announcement month. Top executives were responsible for

more intense selling with insiders buying after prices have fallen and selling before they fall.

According to Noe (1999), managers are opportunistic in timing their trades to increase personal


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gains given they are aware of the intention to trade and obligation to release information. He

reported that managers sell more after the release of good news and buy more after the bad news

releases. Cheng and Lo (2006) provide additional evidence that when managers intend to buy,

increase the number of bad news forecasts while delaying good news to decrease share price.

However, they were unable to show that managers increased good news forecasts or avoid bad

news forecasts when selling, possibly due to the risk of litigation

Prior literature has explored why firms preannounce. Lang and Lundholm (2000) conducted

research that examined whether voluntary disclosures represented an attempt to reduce

information asymmetry between management, shareholders and analysts. A reduction in

information asymmetry lowers the opportunity for investors to profit from informed trading and

therefore reduces the costs to investors of acquiring private information (Diamond, 1985; King et

al, 1990). Moreover, a reduction in information asymmetry increases liquidity in the companys

stock and reduces the cost of capital (Diamond and Verrecchia, 1990). Firms warn in order to

reduce earnings surprises. Typically, investors and analysts do not like negative earnings

surprises and they discount firms that are not transparent about potential negative earnings. King,

et al (1990); Skinner (1994) and Frankel et al (1995) observed that by not being candid about

their future earnings, firms may tarnish their reputation with analysts and investors.

One motivation for pre-announcing earnings is to pre-empt litigation. Skinner (1994) argues that

announcing bad news early can mitigate litigation costs by reducing the number of potential

plaintiffs who could claim that they bought shares at a time when management had held negative

undisclosed information. Consistent with this argument, Skinner (1994) documents that unlike

firms with good news, firms with bad news are more likely to voluntarily disclose earnings-

related information prior to the formal earnings announcement. Further, Kasznik and Lev (1995)

find that firms in high-litigation industries have a higher probability of warnings before large

earnings surprises.

A second motivation for pre-announcing earnings is to affect the overall market reaction to

earnings news. Conversely, Skinner (1994, 1997) suggests that management voluntarily issues

earnings estimates with negative implications in an attempt to avoid shareholder lawsuits that

may be brought upon management for its failure to release material information in a timely

manner. On the other hand, Damodaran (1988, 1989), Mendenhall and Nichols (1988) and Chen


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and Mohan (1994) report that management releases profit warnings by timing the releases of bad

news hence minimize negative market reaction. These arguments suggest that, in the long run,

the market should value profit warning firms for their openness.

Nevertheless, Kasznik and Lev (1995) show that warning firms have higher negative stock

market reactions than non-warning firms given that both have the same level of earnings

surprise. Kasznik and Lev (1995)s finding is counterintuitive. Tucker (2007) argues warning

firms are penalized because announcing firms tend to have more bad news than non-warning

firms.

Bulkley, Harris and Herreiras (2002) noted that profit warnings are the discretionary disclosure

of bad news by companies prior to earnings announcement. They may take the form of a specific

revised earnings forecasts (quantitative warnings) or may be a qualitative statement that simply

states, or implies, that earnings will be significantly less than current brokers expectations.

Approximately half of all companies whose earnings announcements are going to be bad news

warn in advance (Kasznik and Lev 1995).

2.3.2 Insider trades around profit warnings

Numerous studies have investigated insider trading activity around corporate announcements

including equity offerings (Gombola, Lee and Liu, 1997: Ching, Firth and Rui, 2006),

bankruptcy(Seyhun and Bradeley, 1997)and takeovers (Seyhun, 1990).They show that insiders

are aware of these events well in advance of their announcements, in some cases up to years

beforehand. Seyhun and Bradley (1997) report the occurrence of insider selling commencing five

years before the bankruptcy filing that continues up to the announcement month.Insider also sell

before a fall in price and buy after prices had fallen. According to Ke, Huddalt and

Petroni(2003), they trade on specific information about future accounting disclosures up to two

years prior. In particular, insider selling increased three tonine quarters before a break in a string

of consecutive quarterly earnings increases. In their examination of the association between

insider trading and voluntary disclosures, Cheng and Lo(2006) report that insiders withheld good

news and increased the number of bad news disclosures when they purchases shares but they did

not attempt to increase prices when they sold their shares. This is possibly due to litigation

concerns associated with sales.


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The joint signal of insider trading and the voluntary release of profit warnings may convey

insider's private information to the market ,at the least cost in an efficient signal

equilibrium(John and Mishra,1990).Net trading by insiders contribute to the overall information

content of the corporate announcement. With insiders having under diversified holdings in their

own firms, their net trading activity may provide a signal of private information which includes,

in addition to information about the future prospects of the firm, the amount of effort individual

insiders intend to invest .This is particularly interesting in the event of a profit warning because

Donaldson and Weigand (2006)found that in firms that filed for voluntary bankruptcy, insiders

had fewer incentives to maximise shareholders wealth compared to firms experiencing

involuntary bankruptcy .As a result ,the former were net sellers while latter were net buyers in

their own firms.

There is limited research on profit warnings announcement at the NSE. However, Dulacha,

Hancock and Izan(2006) in their study on corporate voluntary disclosures at the NSE finds that

in all years (1992-2001), listed companies make voluntary information disclosures in their

annual reports. However, there are related studies on market efficiency at the NSE. Muragu

(1994) provides evidence consistent with the market efficiency at the NSE. He observed a low

serial correlation of stock prices consistent with weak form efficiency. Kiio(2006)empirical

investigation into market efficiency and the effects of cash dividends announcements on share of

companies listed on the NSE reveal that cumulative market adjusted returns to be significant for

ten days before and ten days after the announcement for dividend paying firms. This indicates

that share prices are indeed responsive to cash dividend announcements.

2.4 Conclusions

Profit warning is one form of corporate disclosure and the above arguments suggests that, in the

long-run, the market should value profit warning firms for their openness. Nevertheless, Kaznik

and Lev (1995) show that warning firms have a higher negative stock market reactions than non-

warning firms given that both groups have the same level of earnings surprise. Kaznik and Lev

(1995) findings is counterintuitive. Tucker (2007) argues that firms are penalized for their

transparency when they make disclosures because announcing firms tend to have more bad news

than non-warning firms.


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CHAPTER THREE: RESEARCH METHODOLOGY

3.1 Introduction

This study aims at establishing the effects of profit warnings on share prices for companies listed

at the NSE. The design is an event study. Mackinlay (1997) noted that an event study measures

the impact of an event on the value of the firm. He also noted that economic impact of an event

can be constructed using security prices observed over a short period. Event study have along

history dating to Dolley (1993) who examined the effects of stock splits and share prices. In this

chapter we define the research design, population and sample size together with the description

on data collection as well as data analysis.

3.2 Research Design

We will conduct an analytical study in which quantitative data will be collected and analysed

across the sampled listed companies using event study methodology. The test for share price

response will be accomplished with an ordinary event study, which is useful when measuring the

effect of an economic event. Event studies have been used since the 1930s with increased

sophistication and modification over the years. Dolley (1933) examined the effect of stock splits

to stock prices. Event studies have been used in a large variety of studies including earnings

announcement, corporate evaluations, debt or equity issues, mergers and acquisitions, investment

decisions and corporate social responsibility (Mackinaw 1997). Campbell et. al. (1997) gives

their structure to an event study; the structure is organised in steps.

3.3 Population

There are three main market segments at the NSE namely: Fixed securities market, Main

investments market and Alternative investments market. For our research purpose, the

population will constitute all the listed companies at the NSE that issued profit warnings

announcement between the years 2003 to 2013. We consider this period adequately long enough

to capture any incidences of profit warning. In 2002, the Capital Markets Authority put in place

the mandatory disclosure rules on profit warning announcements for listed companies.


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3.6 Data analysis

The following methods will be used to analyse the data collected on daily share prices; Average

prices, returns and cumulative returns. This statistical analysis will be carried out using Ms-Excel

by manipulating data on stock prices at the NSE. Share price movements are computed over

several windows ranging in length from one to twenty days. Standard event study procedures are

used to calculate stock returns. The return in any given period is the market model residual,

which is the difference between the stock actual price and the previous price based on the market

for that period divided by the previous price. To determine the individual stock prices betas in

the estimation model, an estimation period of 100 trading days is used, ending twenty days

before the event date. Hence the market adjusted returns are calculated on a 100 day computed

betas for each firm

Statistically significant returns at announcement accumulated over the entire event window,

would support the study on the returns and hence their effect on firm valuation.

3.6.1: Event date specification

The profit warning date is assigned day 0 if it happens on trading day. If announcements are

done on a non-trading day, the next available trading day is assigned day 0. Cumulative returns

are the sum of returns in a given time period. Returns are defined as the difference between the

actual price and previous price divided by the previous price surrounding a corporate event.

The event period is taken to be twenty days before the announcement to twenty days after the

announcement of profit warning. Returns are measured for the announcement period (day -20 to

day +20). Measure of return is constructed on each day over the event window relative to

normal control period (estimation window covering the 100).


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3.6.2 Measuring daily returns

The return in any given period is the market model residual, which is the difference between the

stock actual price and the previous price based on the market for that period divided by the

previous price.

Returns = (Actual PricePrevious price)/ Previous price

Where the Actual price also known as the average price is given by the average of Highest and

Lowest price of the stock price at a given day expressed as:

Actual price = (Highest price + lowest price)/2

The highest and lowest prices are provided as secondary data from the Nairobi Securities

Exchange for the specific days.

3.6.3 Measuring the Cumulative Returns

The cumulative returns are gotten by adding the return for the day to the previous day returns. Its

important in indicating the growth in returns over the period of analysis whether its increasing or

decreasing over the period.

In some days, the returns decrease thus having a negative effect on the cumulative returns

whereas in some days, the returns increase having a positive effect on the cumulative returns.


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The average daily prices for EABL Company as showed in theNairobi Securities Exchange 20

days before and 20 days after profit announcement or event date, the prices are increasing from

day 20 to day 3 before the profit warning date where the price falls and raises the day 0. After

profit warning shows a drastic price decrease up till the 14th

day with no price increases.

Figure 4.2.2: Kenya Airways company 20 days before and 20 days after profit warning

announcement

Figure 4.2.2 shows the share price of Kenya Airways in the year 2012 on 6th

November as day 0,

being the day the company issued the profit warning and for 41 day event window in the period

under review. For more details about the share prices, the returns and cumulative returns see

appendix 3.

The findings show that the share prices for Kenya Airways fluctuates more before and after

profit warning announcement. Before the profit warning the share prices increases between day

20 and day 12 then remains constant for 10 days, it drops sharply during the day of issue of profit

10.6

10.8

11

11.2

11.4

11.6

11.8

12

12.2

12.4

12.6

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

Kenya Airways share prices trend

average


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warning. After the price warning the share prices increases for the next 6 days and stabilises for

10 days continuously and after while drops drastically for the remaining four days.

Figure 4.2.3: CMC Holding company 20 days before and 20 days after profit warning

announcement.

Figure 4.2.3 shows the share price of CMC Holding Limited in the year 2011 on 7th

October as

day 0, being the day the company issued the profit warning and for 41 day event window in the

period under review. For more details about the share prices, the returns and cumulative returns,

see appendix 4.

The analysis shows that for CMC Holding company the share prices fluctuate from day 20 to day

0 with major increases and decreases. After the profit warning the share prices keeps fluctuating

for 10 days then increases drastically for 7 days before it drops for the day after and remains

constant.

14

14.5

15

15.5

16

16.5

17

17.5

18

18.5

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHARE

PRICE

DAYS

CMC Holding share price trend

average


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Figure 4.2.4: Total Kenya share prices trend 20 days before and 20 days after profit

warning announcement.

Figure 4.2.4 shows the share price of Total Kenya limited in the year 2012 on 29th

June as day 0,


under review. For more details about the share prices, the returns and cumulative returns, see

appendix 5.

From the analysis, total share prices keeps fluctuating but insignificantly increasing before the

profit warning issue. Thereafter the price warning the share prices remains fluctuating before

drastically decreasing on the 5th day and starts increasing towards day 6 and remains levelled

with insignificant increase towards day 20.

13

13.5

14

14.5

15

15.5

16

16.5

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

Total kenya share price trend

average


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Figure 4.2.5: Sameer Africa share prices trend 20 days before and 20 days after profit


Figure 4.2.5 shows the share price of Sameer Africa Limited in the year 2012 on 29th

June as day

0, being the day the company issued the profit warning and for 41 day event window in the


see appendix 6.

The results show that before and after profit warnings, the share prices remains levelled with

minimal fluctuations. Before the profit warning, the share prices remains constant for 10 days, it

had decreased from day 20 to day 10 but with insignificant variations. After profit warning, the

share prices remains constant with minimal variations on daily prices quoted.

0

1

2

3

4

5

6

7

8

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SH

AREPRICE

DAYS

Sameer Africa Share price trend

average


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Figure 4.2.6: Sasini limited share prices trend 20 days before and 20 days after profit

Figure 4.2.6 shows the share price of Sasini limited in the year 2012 on 2nd

August as day 0,



appendix 7.

The analysis revealed that the share prices for sasini africa decreases for 6 days before the profit

warning and there before had remained relatively constant for 14 days towards the 20th day

under study before profit warning. After the profit warning the share prices shoot up to the prices

before the profit warning then again drops on the next day and thereafter tends to stabilise

towards day 20.

10

10.5

11

11.5

12

12.5

13

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

Sasini share price trend

average


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Figure 4.2.7: Access Kenya share prices trend 20 days before and 20 days after profit


Figure 4.2.7 shows the share price of Access Kenya Group limited in the year 2012 on 12th

July

as day 0, being the day the company issued the profit warning and for 41 day event window in

the period under review. For more details about the share prices, the returns and cumulative

returns, see appendix 8.

From the analysis the results found that before the profit announcement was issued the share

prices remains significantly fluctuating with large decrease on the 18th and 16th day beforestarting to decrease again, then after the profit warning the prices decreases for 8 days, it

recovers for 4 days and starts to fluctuate towards the 20th day and retaining its price before the

profit warning issue.

4.4

4.6

4.8

5

5.2

5.4

5.6

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHA

REPRICE

DAYS

Access kenya share prices trend

average


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Figure 4.2.8: Eveready East Africa share prices trend 20 days before and 20 days after

profit warning announcement.

Figure 4.2.8 shows the share price of Eveready East Africa in the year 2010 on 30th

November

as day 0, being the day the company issued the profit warning and for 41 day event window in

the period under review. For more details about the share prices, the returns and cumulative

returns, see appendix 9.

From the analysis its clear that before the profit announcement the share prices for Eveready

Kenya were significantly decreasing with calculated differences, at day 0, the share price sharply

falls and after the profit warning the share prices forms a convex behaviour for the first 10 days

of profit warning announcement before starting to fluctuate thereafter trying to recover and level

as before the announcement.

0

0.5

1

1.5

2

2.5

3

3.5

4

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

Eveready Share price trend

AVERAGE


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Figure 4.2.9: East African cables share prices trend 20 days before and 20 days after profit


Figure 4.2.9 shows the share price of East African cables in the year 2010 on 14th

July as day 0,


under review. For more details about the share prices, the returns and cumulative returns see

appendix 10.

From the analysis, its clear that before the profit warning announcement the share prices had

been decreasing for the 1st4 days then remains constant for 10 days, increase for the next 4 days

before sharply decreasing after the profit warning. After the profit warning the share prices

increases for the next 2 days before starting to decrease on the 5th day and drastically drops

significantly towards the 20th day.

17

17.5

18

18.5

19

19.5

20

20.5

21

21.5

22

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SH

AREPRICE

DAYS

East African cables share price Trend

average


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Figure 4.2.10: Kakuzi share prices trend 20 days before and 20 days after profit warning

announcement.

Figure 4.2.10 shows the share price of Kakuzi limited in the year 2012 on 30th

November as day0, being the day the company issued the profit warning and for 41 day event window in the


see appendix 11.

From the analysis the share prices trend shows that before the profit warning the share prices

remains levelled on a steady state with significant fluctuations thereafter the profit warning the

prices shifts up for 2 days before dropping on a bigger margin and then keeps fluctuating but

with more ups than downs up to 19th day before the share prices starting to move downwards.

64

65

66

67

68

69

70

71

72

73

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

Kakuzi share price trend

average


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Figure 4.2.11: Longhorn Kenya limited share prices trend 20 days before and 20 days after


Figure 4.2.11 shows the share price of Longhorn Kenya limited in the year 2012 on 29 thJune as


period under review. For more details about the share prices, the returns and cumulative returns

see appendix 12.

From this study the share prices for longhorn Kenya before the profit warning increases for the

first four days before fluctuating for the next 9 days with major differences and thereafter

fluctuates more as it moves downwards. After the profit warning longhorn share prices decreases

for the next 18 days with massive increases for the next one day before starting to drop again

sharply.

16.5

17

17.5

18

18.5

19

19.5

20

20.5

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

Longhorn Share price trend

average


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Figure 4.2.12: National Bank OF Kenya share prices trend 20 days before and 20 days

after profit warning announcement.

Figure 4.2.12 shows the share price of National Bank of Kenya in the year 2013 on 22th

March as


period under review. For more details about the share prices, the returns and cumulative returns

see appendix 13.

From the results, it showed that national bank share prices fluctuates more on a increasing

manner before the profit warning announcement and increases a while on profit warning before

going to steady state for the next 16 days with insignificant percentage changes.

0

5

10

15

20

25

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

National bank share price trend

AVERAGE


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Table 4.2.13: Mumias Sugar company share prices trend 20 days before and 20 days after


Figure 4.2.13 shows the share price of Mumias Sugar Company in the year 2013 on 22nd

February as day 0, being the day the company issued the profit warning and for 41 day event

window in the period under review. For more details about the share prices, the returns and

cumulative returns, see appendix 14.

Its clears that before the profit announcement, the share prices quoted in nairobi securities

exchange was seen to be constant for the 20 days considered for this study before with minimal

fluctuations and slight differences on the daily prices quoted. After the profit warning

announcement the share prices increases and decreases at the same time with sharp increase and

decrease on the 15th day before the prices starts to move much down.

0

1

2

3

4

5

6

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

Mumias share price trend

average


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Table 4.2.14: CFC Stanbic share prices trend 20 days before and 20 days after profit


Figure 4.2.14 shows the share price of CFC Stanbic in the year 2006 on 31 stJanuary as day 0,



appendix 15.

From the analysis, its very clear that cfc bank share prices before profit warnings fluctuates more

with sharp increases and decreases at the same time before it start to move down completely onthe 8th day. After the profit announcement the share prices moves downwards with major

fluctuations but with insignificant increases compared to the decreases.

60

62

64

6668

70

72

74

76

78

80

82

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

AxisTitle

Axis Title

CFC bank share price trend

average


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Table 4.2.15: Uchumi Kenya share prices trend 20 days before and 20 days after profit


Figure 4.2.15 shows the share price of Uchumi Super market limited in the year 2005 on 25th

August as day 0, being the day the company issued the profit warning and for 41 day event

window in the period under review. For more details about the share prices, the returns and

cumulative returns, see appendix 16.

From the findings, its evident that before the profits warning issue the share prices were constant

from the 20 the day to 10th day, it starts to increase for 6 days before decreasing for 3 days. After

the profit warning Uchumi share prices moves downwards but with minimal variation from the

expected mean on the event day in particular.

0

5

10

15

20

25

20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20

SHAREPRICE

DAYS

Uchumi share price trend

average


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CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS

5.1 Summary and conclusion of findings

The objective of the study was to investigate the impact of profit warning on the stock prices of

the listed companies in Nairobi Security Exchange.

From the analysis of the findings it was found that among the listed companies who declared

profit warning between 2003-2013 East African breweries limited, Kakuzi tea and CFC bank

have the highest stock prices on average. East African breweries limited has the highest quoted

stock prices on average before profit warning issue.

Mumias Sugar Company, Eveready, Access Kenya and Sameer Africa shows the lowest quoted

stock prices in Nairobi stock exchange on average 20 days before profit warning declaration by

company management. Most of the companies indicated moderate stock prices for the period

under study.

To elaborate further 20 days after companies profit warning declaration the share prices remains

constant for most companies with minimal fluctuation in some companies. East African

breweries limited, Kakuzi limited prices and CFC Stanbic, records the highest quoted stock

prices for 20 days under consideration after profit warning with Mumias Sugar Limited,

Eveready, Access Kenya, Sameer Africa and Sasini tea records the lowest quoted stock prices on

average.

From the literature review there is wide analysis and discussion concerning the profit warnings

despite the emerging evidence on the randomness of stock prices changes, there were occasional

instances of anomalous price behaviour, where certain series appeared to follow unpredictable

paths. The study found that earning announcement may carry some enormous implications for

the market and stock prices but it was hard to determine the magnitude of the impact because the

period considered for the study was not representative. The findings showed statistically

significant negative stock prices fluctuations despite to some companies remaining unchanged.


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5.2 Policy recommendations

This study recommends that the company managers should undertake their profit warnings

openly to the public to increase their credibility.

The fund managers need to come up with clear framework and tools to monitor performance of

their business to

final defended-3

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