What is the impact of research on stock prices? It's a valid question, but there is no easy answer.
On a quantitative basis, you could perform a regression analysis to determine the correlation between changes in a stock's price and the publication of a research report. However, you would need to filter out the effect of "noise," the impact of news releases, competitor news releases, economic reports and other macroeconomic factors. After all that work, the results may not show statistical significance, which means that you would not have found any direct relationship between the stock price's movement and the report's issuance. In addition, the results can be manipulated by a change in the length of time period being studied.
On a qualitative basis, it has been proven that having more information about a company in the marketplace is better than less information, but the return on the investment in research is nevertheless hard to calculate. On the other hand, objective information in the marketplace about a company reduces the "halo effect" on that company if its competitor announces unexpected bad news. With objective information, the market can evaluate the news event's impact on both companies.
How Research Benefits Investors
While quantifying the benefits is difficult, most of research's value lies in the unquantifiable benefits provided to investors:
- Comparative operating and valuation data on a company;
- Earnings estimates and target valuations based on reasonable data included in the report; and
- A reliable source of independent, third-party information on a continuous basis so that investors can track performance and evaluate an investment.
Research coverage benefits are not immediate, and the decision to invest in stock research is generally a long-term process. It takes time for investors to familiarize themselves with a stock and get comfortable with a new company and its investment potential.
Research, however, provides the market with more information and increases market efficiency, but it is hard to determine exactly when a report will convince an investor or a fund manager to buy a stock. It could be near the publication date or months later, but it will be the third-party report that helps provide the information on which that investor makes his or her decision.
However, investors should beware of "research" reports that advertise how the stocks these reports followed rose immediately after the report's publication. While it may be true that the stock rose after the report was issued, there is generally no way to prove beyond a reasonable doubt that the report was the sole reason why the stock rose. If you see such a claim, check the long-term trend of the stock's price and see if it fell back after a few days or weeks.
The Bottom Line
Although the total return on the investment in research is hard to quantify, the information provided via third-party research has tangible value. Objective research provides information to the market to reduce uncertainty. Even though the nature of the stock market prevents us from isolating any one of the many variables that affect a stock's price, no one can disagree that in the long run, greater available information means greater market efficiency.