General interest in the financial markets has risen rapidly in recent months in the wake of the high level of uncertainty associated with the current pandemic. More and more people are following the movements of shares and using various sources of information to do so. Especially on digital platforms – e.g. YouTube or Instagram – you can find more and more content dealing with the topic. But classic public media also regularly report on the markets or individual companies. This raises the question of what the implications are for private investors when they make investment decisions based on the public information they receive from the media. This post will look at how media coverage can affect investors, what changes this brings in terms of private returns, and how (new) information is taken into account when pricing stocks in general.
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It is impossible for a single person to have an overview of all available stocks, as the number is far too high for that. When looking for investment opportunities, a search problem arises, as individuals have to decide which stocks they want to look at more closely. Moreover, many – especially small, listed companies – are not even known to the general public. The attention of potential investors is therefore in part strongly steered by public media, in that they report on specific markets, industries and individual companies. The reporting as well as the general media interest thus direct the attention of private investors to certain companies or shares. This increased attention often leads to short-term price increases, as private investors predominantly do not hold short positions and thus only the demand is influenced. However, such investments, which are driven by media coverage, usually lead to lower returns for private investors. One reason for this is the incorrect assessment of the new information, which is often less significant than an inexperienced investor would expect, and people also tend to overestimate themselves. Overestimating one’s own abilities leads to higher trading frequency, which in turn often results in lower returns. It would be more profitable for an inexperienced investor to focus on a long-term investment horizon and a diversified portfolio.¹
However, media coverage alone does not have an impact on share prices. For changes to become visible, investors must also perceive the information presented. Thus, it is not directly the consideration in public media that is relevant, but rather the attention of investors. However, it is difficult to assess whether consumers of public news actually perceive the information. One approach to get around this problem is to look at Internet searches. Smales (2021) therefore considered in his work, for example, the Google Search Volume, since publicly available information is displayed via Google Search and the search must be active, so that the attention of the person searching is also given. He has found that search volume acts as a suitable indicator of attention with regard to individual stocks or companies and that increased attention is associated with below-average returns and higher volatility.² These findings are similar to the findings of Fang & Peress (2009), who showed that publicly traded companies that do not receive mass media coverage have significantly higher returns. In addition, they found that the amount of media coverage remains largely stable for individual companies, so this can be understood as a specific company characteristic. It is interesting to note that although public media have a strong influence on attention, they do not change the individual opinion of their audience about a company or a stock.³
If one wants to try to explain these observations, it is first necessary to look at how share prices arise and how they change. As described, when companies or shares are viewed in the mass media, attention among (potential) investors often increases as well. If they decide to buy the shares portrayed, demand increases and this increase usually results in rising share prices. Media coverage could thus lead to a rise in share prices without the fundamental company data having changed. One conceivable result of this would thus be that listed companies which are in the public eye or enjoy a high degree of recognition within the population tend to be valued higher than those which are not in the public eye. So if such shares tend to be overvalued as a result of media interest, this could provide an explanation for why companies that are not in the public eye to such an extent generate higher returns. A key aspect that should also not be forgotten is that share prices do not reflect the actual economic situation of individual companies or markets, but rather investors’ expectations. Moreover, the time lag in absorbing information from mass media potentially puts private investors at a disadvantage. Before news relevant to stock market movements is considered in mass media, this information is often already published in specialized media. If a private investor receives information in the public media that leads the person to want to acquire certain shares, it can usually be assumed that institutional investors in particular have already processed this information and taken it into account in their own activities. If this is indeed the case, the probability is relatively high that the (positive) news is already included in the current share prices.
One recommendation that private investors often hear is that they should only invest in shares of companies if they are convinced of the respective company and are familiar with its products and services. At this point, however, it is questionable whether such decision patterns actually lead private investors to invest in more profitable companies with high returns. It is possible that the higher returns result from a change in the way such investments are realized. If investors are convinced by a company, they may be more willing to tolerate negative headlines and hold their positions for the long term rather than dumping them immediately. In the previous sections, we have already considered that high trading frequency lowers the returns of inexperienced investors in particular. Under certain circumstances, therefore, investors actually benefit from the above recommendation, not because they make particularly good decisions, but because the long-term investment horizon reduces the uncertainty caused by short-term price fluctuations and fewer irrational or emotional selling decisions are made. This realization could also reduce the problem of overestimating one’s own abilities, as investors could become aware that it is not their choice of stocks but their long-term investment horizon that is the reason for the higher returns of their own portfolio.
Public coverage in the media has a significant influence on which stocks private investors consider for their portfolio. However, reporting only has a direct influence if investors actually perceive the information. Mass media can thus influence private investment decisions by directing attention. However, private investors should always be aware that they tend to be at a disadvantage when it comes to absorbing information. This is particularly true when comparing them with institutional investors. Investments in high-profile companies tend to have below-average returns, and the asymmetric distribution of information increases the risk for private investors. The latter should be constantly aware that news in mass media is often less significant than they assume and that there is always a risk of overestimation. However, it should be emphasized at the same time that everyone can profit from the financial markets as long as one’s own emotionality is kept under control and no irrational decisions are made.
¹ Barber, B. M., & Odean, T. (2008). All That Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors. The Review of Financial Studies, 21(2), 785–818.
https://doi.org/10.1093/rfs/hhm079.
² Smales, L. A. (2021). Investor attention and global market returns during the COVID-19 crisis. International Review of Financial Analysis, 73, 101616.
https://doi.org/10.1016/j.irfa.2020.101616.
³ Fang, L., & Peress, J. (2009). Media Coverage and the Cross-section of Stock Returns. The Journal of Finance, 64(5), 2023–2052.
https://doi.org/10.1111/j.1540-6261.2009.01493.x.
