According to Datamonitor (2010), the influence of peer-based advice, such as user-generated ratings on Amazon.com or Yelp.com, is increasing while traditional advice (e.g., from Consumer Reports or the Michelin guide) is decreasing. This trend is starting to emerge in financial markets as well. The authors assess the performance of investors-turned-advisors and ask the following questions:
Do peer opinions impart value-relevant news or are they merely random chatter (value-relevance hypothesis)?
Do peer opinions predict subsequent earnings surprises?
What are the Academic Insights?
By employing textual analysis (focusing on the fraction of negative words both in SA articles and follow-up comments), the authors study user-generated opinions from Seeking Alpha (SA) on a sample of more than 7,000 companies during 2005-2012 and find the following:
YES- views expressed on SA are generally confirmed by subsequent stock market performance. Future abnormal returns are 0.38% lower when the fraction of negative words in SA articles is 1% higher and 0.19% lower when the fraction of negative words in SA comments is 1% higher. This prediction holds over different investment horizons and they tend to increase with the length of the holding period.
YES- views expressed on SA are generally confirmed by subsequent earnings further below market expectations as measured by financial analysts’forecasts.
The authors perform a number of robustness checks like the inclusion of control variables reflecting analyst recommendation upgrades/downgrades, positive/negative earnings surprises and the negative fraction of negative words in the DJNS articles.
Why does it matter?
With the usual caveat that sample size is limited, this study adds to the literature studying the usefulness of the internet as a source of valuable information and specifically, the usefulness of peer-based advice in financial markets.
The Most Important Chart from the Paper:
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
Social media has become a popular venue for individuals to share the results of their own analysis on financial securities. This paper investigates the extent to which investor opinions transmitted through social media predict future stock returns and earnings surprises. We conduct textual analysis of articles published on one of the most popular social-media platforms for investors in the United States. We also consider the readers’ perspective as inferred via commentaries written in response to these articles. We find that the views expressed in both articles and commentaries predict future stock returns and earnings surprises.
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016).
Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.
Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only. Past performance is not indicative of future results, which may vary. There is a risk of substantial loss associated with trading stocks, commodities, futures, options and other financial instruments. Full disclosures here.