Monday, September 28, 2009

Name Recognition

What makes stock prices move? People put an awful lot of effort into reading technical analysis and economic indicators, but one recent study suggested that might be less than half the story. According to professors at the Universities of Michigan and California, the biggest part of a stock's movement is name recognition.

The researchers claim that as much as 70 percent of the variation in stock returns is explained by changes in investor recognition, which they define as the number of investors who know about a stock and hence consider it for their portfolio. “Efficient market theories say sophisticated arbitragers would step in to keep the prices in line with fundamentals, and we show that doesn’t happen," says Richard Sloan, the California professor. "When a lot of investors get excited about a stock, the price moves accordingly."

This is not so surprising, especially to investors who subscribe to the Peter Lynch school of investing, in which people buy into companies that they see doing well. But the magnitude of the effect is eye-opening, particularly if you're trying to choose between buying Apple or buying Air Products & Chemicals Inc.

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