Stock selection: it pays to read beyond the headlines

As the peak ISA-selling season approaches, new research highlights that it pays to look beyond superficial information before investing

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New research by London Business School (LBS) involving thousands of financial web site users suggests that retail investors who buy stocks because they catch their attention will typically end up paying more for such investments.

The research reveals that companies promoted in the news enjoy a significant uplift in abnormal returns on the day of their earnings announcement compared to firms that do not receive media attention.

This premium stock price was calculated at approximately 160 basis points (or almost 2%) for the day of announcement alone. The effect of media attention on stock price was found to be more pronounced for smaller companies and those which normally have little visibility, companies which report negative earnings or if announcements are made on slow news days causing the earnings announcement to attract more attention.

The field study assessed the stock price of 169 companies with earnings announcements during an 11-week period. These firms were randomly selected to have their news articles shown to financial web site users. A further 169 firms were selected from a total group of over 1,134 companies to serve as a control sample, being the most similar to the 169 treatment firms.

On the day of earnings announcements, media articles for the randomly selected sample of companies were given prominent positioning on the front page of Yahoo! Finance to a one percent sample of users.

Dr James Ryans, Assistant Professor of Accounting and Dr Alastair Lawrence, Associate Professor of Accounting, both of LBS, led the research.

“We’re getting close to the tax year-end when people look to use up their investment allowances and so this research demonstrates that it’s important to avoid rushed decisions.

“Selecting stocks which are attracting a high level of attention could mean you get a lower return on your investment. So you need to look beyond superficial reporting for some genuinely good reasons to invest in a stock or sector,” said Dr Ryans.

Dr Lawrence cautioned: “A key take-away from our research is the importance of a broadly diversified portfolio and to be wary of ‘hot’ stocks and sectors. So don’t follow the herd but be sure to look for good reasons to invest.

He continued: “Last-minute decisions, particularly at this time of year, increase the chances of paying over the odds. So give yourself the time to consider, for example, the company’s business model, profitability, recent growth, its outlook, dividend payments and recent valuations. Price-earnings ratios and forecasts of ongoing growth and profits can also help you compare one stock against another.

“Our findings also highlight how difficult it can be for individual investors to select stocks when there are many thousands of different companies both in the UK and the US.”

“Although financial reports are a great source of company information they’ve grown enormously in recent years and the laudable demands for disclosure and transparency make them difficult to digest for the average investor. As a result, people naturally look to the news media for information, but they should read beyond the headlines for reasons to select a particular stock or sector.”

Background to the research

This study used a field experiment to examine the effects of promoting earnings announcement articles on the equity markets. On the day of earnings announcements, media articles for a random sample of firms were given prominent positioning on the front page of Yahoo Finance to a one percent sample of Yahoo! Finance users. Yahoo! Finance is the most popular site for financial news worldwide.

Promoted and control firms were balanced across earnings news and fundamental characteristics, and promoted firms experienced an increase in abnormal returns on the day of the earnings announcement relative to control firms. The field study ran on Yahoo Finance from 12 May to 28 July, 2016. During the experiment, 169 firms were sampled as treatment firms.