Using Google to forecast an earnings pop (or plunk)

Google’s my friend.

Not only do I rely upon it for email, video, and of course, search, but I’m using it to invest  better and smarter (the Tradestreaming way, right?).

Let me explain:

One of my first podcasts on Tradestreaming Radio was with finance professor, Joey Engelberg. In How to use Google search data to invest, I asked Engelberg about a paper he had recently published that showed how useful Google could be in forecasting stock prices.

Using Google Search Data to Invest by tradestreaming

Specifically, Engelberg noticed:

1. Google search volume likely measures the attention of retail investors
2. and does so in a more timely fashion that existing proxies of investor attention

And of course, stock prices tend to follow attention.

So, an increase in Google search frequency (SVI) predicts higher prices in the next two weeks and also contributes to a large first-day return (and long-run underperformance) of IPO stocks.

Awesome stuff and after we spoke, Joey kind of went underground (he did leave UNC and headed for UCSD), using his research to make coin at a hedge fund. I spent a whole chapter in Tradestreaming (my book) describing co-lateral research — stuff that’s inherently non-financial in nature (Google search, Amazon ratings, etc) to help us make better investing choices.

Now a new paper shines light on how Google search reflects investor information demand and what that means for earnings news.

Google can predict an earnings pop (or lack of)

In Investor Information Demand: Evidence from Google Searches around Earnings Announcements, a trio of researchers found that

abnormal Google search increases about two weeks prior to the earnings announcement, spikes markedly at the announcement, and continues at high levels for a period after the announcement

So regardless of the availability of news, PR, and financial portals, investors use search to access financial information and news about stocks.

What it also means — and this is the bigger takeaway from the paper — is that a lot of searches conducted prior to an earnings release have the effect of preempting the actual news.

In plain English, if investors spend a lot of time searching information before a firm releases its earnings, the less they’re surprised when the earnings are released. It dampens the effect (or “preempts” them, as the authors of the paper call it).

• So, abnormally high search activity –> potentially minimal earnings movement
• lower search volume –> more potential for a pop

Here’s an example from Microsoft’s (MSFT) search volume in 2006:

While interesting, this info isn’t quite actionable yet as an investing strategy for individual investors. But it’s definitely an important data point to use if investors are playing earnings or thinking of bailing before an earnings report.

And those findings make sense, right? Investors are doing the work and that aids in price discovery, leaving less potential to be surprised.

Check out Google Insights for Search and see what’s going on in your favorite stock.

More Resources

Here are some of the leading research papers on how Google can help investors make more informed — better — decisions.