Want to Find the Next Hot Stock? Consider Listening to the Media
Almost 95% of finance professions fail to beat the market over a 15-year period. For individual investors, the percentage is almost certainly lower. To have any chance to join the ranks of the select few investor that outperformed passive index benchmarks, investors need a reliable trend they can act on. Fortunately, researchers Alexander Hillert and Michael Ungeheuer possibly uncovered such a trend.They found that stocks highly covered by the media outperformed, but how and if investors can exploit this trend is a little tricky.
After controlling for the tone of the media’s coverage and firm characteristics, Hillert and Ungeheuer found that the 20% of stocks the media wrote the most stories about outperformed the 20% of stocks least covered by 2.76% a year. This outperformance does not diminish over time: the top quintile beat the bottom quintile by 2.76% in the second year and 2.28% in the third year. Why does this phenomenon occur? Media stories that increase the public’s awareness of a stock lead to more people wanting to buy the stock, pushing up demand and thus the stock’s price.
While stocks with the highest media coverage perform the best, the amount they outperform their similar sized peers varies by market capitalization. After dividing firms into quintiles based on market size, Hillert and Ungeheuer discovered that high coverage stocks performed better than low coverage stocks by .47% per year for the quintile with the smallest companies. For the quintile with the largest companies, this difference drops to a .17% annualized return. Smaller companies’ stock benefits more from media coverage than for large companies because investors know more about large companies, so media coverage is less likely to simulate as much demand. Additionally, since large-cap stocks exhibit less volatility than small-cap and medium-cap stocks, large-cap stocks generally do not move as much on new information such as a media article. Of course, investors must weigh the increased risk of investing in small-cap stocks against their superior returns stemming from media coverage.
However, buying small-cap stocks highly covered by the media does not always result in exceptional returns. Hillert and Ungeheuer found that stocks in the top quintile in terms of increases in coverage outperform the bottom quintile by 10.68% in the first year. However, in the course of the next two years, these stocks underperform by 5.04%. This finding is consistent with the idea that stocks can become overvalued when enthusiastic investors find out about them in the media. As the price soars above the fundamental value of the stock in the first year, several investors will consider the stock overvalued and sell it in the flowing years, resulting in a lower stock price. Consequently, to maximize returns, investors should buy stocks that will likely receive a lot of media coverage in the future before they are everywhere in the media. However, trying to predict which stocks the media will cover frequently in the future as well as which stocks investors are not fully aware of yet are arguable as hard as picking marketing bearing stocks in the first place.
Although media coverage boosts stock returns, media stock recommendations frequently highlight stocks that underperform the market in a positive light. For example, CNBC TV personality Jim Cramer recommends specific stocks on his show “Mad Money.” Cramer also co-manages his Action Alerts Plus portfolio, which had a 63.53% return from 2000 to 2015 compared to the S&P 500’s 70.04% return without investing dividends in the same period. Although Cramer’s portfolio consists of different stocks than the ones he recommends on “Mad Money,” he frequently suggests investing in a lot of the same stocks. For instance, Cramer repeatedly recommended buying Allegran PLC (AGN) on “Mad Money” and in his portfolio in 2015 and 2016 as the Stock tumbled about 55% from June 30, 2015 to January 2019. Cramer is not the only media culprit when it comes to losing to the market. Stocks picked by active managers often get highlighted in media articles. However, with 95% of these active managers unable to outperform the market, their media stock recommendations will almost certainly lag the market.
Excluding media suggested stocks, should investors invest in small-cap stocks the media loves mentioning? While these stocks outperform, investors face the risks of buying stocks the media over hyped and of the media converging other stocks instead. With most investments, taking on more risk results in greater expected returns and picking highly covered media stocks is no different. If investors desire riskier investments with a better chance than other stocks to beat the market, highly covered media stocks could be the way to go.
Written By Christopher Lane, Undergraduate Economics Student
1. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2689652
2. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2689652
3.https://static1.squarespace.com/static/568f03c8841abaff89043b9d/t/5734f6e2c2ea51b32cf53885/1463088868550/HartleyOlson2016+Jim+Cramer+Charitable+Trust+Performance+and+Fact or+Attribution.pdf
4. https://www.marketwatch.com/story/jim‐cramer‐doesnt‐beat‐the‐market‐2016‐05‐13
5. http://www.aei.org/publication/more‐evidence‐that‐its‐very‐hard‐to‐beat‐the‐market‐over‐time‐95‐of‐financial‐ professionals‐cant‐do‐it/