Stock Prices Follow Investor Sentiment More than Fundamentals
After reviewing the data this researcher concludes that “news about fundamentals in analysts forecasts of future earnings account for only about 30% of explainable variation in stock returns. The Remaining 70% is explained by changes in investor recognition”
Introduction (Via Haas.Berkeley)
What makes stock prices move? That’s a million-dollar question, and one that Haas School Professor Richard Sloan poses and answers in his recent paper “Investor Recognition and Stock Returns” (co-authored with Professor Reuven Lehavy, University of Michigan). Sloan maintains investor “recognition,” not earning results and related fundamentals, are the driving force — accountable for more than 50 percent of explainable stock price variations.
In his research, Sloan explains that the conventional textbook approach to stock valuation is to study a company’s fundamentals, such as cash flow and the return on assets. Contrary to convention, Sloan’s work proves that sentiment and emotion among investors carry unexpected clout.
Additional Excerpts (Via Haas.Berkeley)
“Efficient market theories say sophisticated arbitragers would step in to keep the prices in line with fundamentals, and we show that doesn’t happen. When a lot of investors get excited about a stock, the price moves accordingly,” says Sloan, who holds the L.H. Penney Chair in Accounting and studies the relation between accounting information and stock returns.
Sloan says the results are “both striking and surprising, because we teach that stock markets are efficient and based on fundamentals.” The results suggest that investors, analysts, and corporate managers should pay attention to changes in investor recognition. They also shed light on why companies hire investor relations professionals and investment bankers and explain why non-fundamental events, such as index additions and initiation of analyst coverage, cause stock prices to increase.