Can social media provide value in evaluating companies?

As you try to identify undervalued companies or startups worth investing in, you need to know what sources of information are reliable and, ideally, underutilized. Social media ranging from Twitter to crowdfunding discussion forums to social market analysis sites offer a window into what the investing public at large thinks about market trends as a whole or about the direction a particular stock or company is heading in. But is the opinion of the average investor of any value to you in deciding on your next steps?

Social Media

Before we can answer that question, we need to ask a different question: How can we say what “social media” has to say about a particular firm when social media encompasses such a sprawling body of information? Here the answer is sentiment textual analysis. In short, a range of tools exist for taking a large body of text (let’s say, all the recent tweets referring to a particular company) and analyzing the overall sentiment, or feeling, it’s expressing. In our case, if you want to keep it simple, just look at whether the overall sentiment is positive or negative. In other words, look to see whether potential investors, in writing about the company, use words that show they’re feeling good or bad about the company.

Now we know that the tools are out there for aggregating people’s social media opinions about potential investments. But we’re still left with a second question: Does the average investor’s opinion hold value beyond what the expert analysts have to say? Well, social media is a great example of what James Surowiecki calls “The Wisdom of Crowds.” You have a large, diverse, independent group of people whose collective wisdom should actually be greater than that of any individual experts.

James Surowiecki, Wisdom of the Crowds
James Surowiecki

But enough with the theory. We can actually prove it to you. Hailiang Chen et al, in a 2013 article called “Wisdom of Crowds: The Value of Stock Opinions Transmitted Through Social Media”, test out the theory on one of the most popular social sites for investment opinion and analysis, Seeking Alpha. On Seeking Alpha, investors write articles with their take on the latest trends and companies, the editorial board reviews the articles before posting them, and then all users can post comments. Authors get paid according to page views, thereby ensuring that they have an incentive to write good quality analysis.

Chen et al took a huge data set of 97,000 articles and the ensuing 460,000 comments, altogether over 185,000 independent users. That’s a real crowd: diverse, independent, each bringing their unique pieces of information and points of view, and motivated to get it right in order to earn page views and site prestige. They analyzed the negative sentiments in the articles and comments, using L&M’s sentiment dictionary designed specifically for analyzing financial writing.

The results were very clear. Negative feelings expressed in users’ writing predicted both future stock returns and earnings surprises – meaning that the next reported earnings were significantly worse than what the analysts had predicted. In other words, the average investors were able to predict a downturn even where the analysts missed it. They also compared their results to what you would get by analyzing the Dow Jones News Service over the same period of time, but the collective wisdom of the average investors outdid the DJNS as well. Another interesting point is that when the commenters disagreed with the author, the commenters tended to be right – another example of the crowd beating the expert.

Now, a site like Seeking Alpha doesn’t represent collective wisdom in a totally pure sense. First of all, a well-written piece doesn’t just predict the future, it could directly impact on it by convincing others to buy or sell. In addition, because everyone can view the comments, there’s the potential for a dominant voice to carry the day, limiting the diversity of opinion expressed. But in general, a small amount of communication between players doesn’t have to damage the value of collective wisdom.

In short: social media can be a hugely valuable source of wisdom on companies’ value and well worth factoring into your investing strategy.

Do you listen to social media as a source of investing information?

Mike SchultzJune 28, 2015

Mike Schultz

I am a contributing author who writes about crowd wisdom. I love reading broadly and synthesizing diverse sources of wisdom, but it's so cool when you realize the crowd itself does that even better.