Exploiting Stocks that Incorporate News Slowly

Can investors identify stocks that incorporate news slowly enough to allow exploitation? In their August 2019 paper entitled “Tomorrow’s Fish and Chip Paper? Slowly Incorporated News and the Cross-Section of Stock Returns”, Ran Tao, Chris Brooks and Adrian Bell classify stocks incorporating news quickly (QI) or slowly (SI) into prices and investigate implications for associated future returns. Specifically, they each month:

1. Assign a sentiment score to each current-month news article about each stock based on words in the article.
2. Double-sort stocks by thirds based first on current-month abnormal (adjusted for size, industry value and industry momentum) returns and then on news sentiment scores, yielding nine groups.
3. Classify stocks that are: (a) high return/low sentiment (HRLS) or low return/high sentiment (LRHS) as SI; and, (b) high return/high sentiment (HRHS) or low return/low sentiment (LRLS) as QI.
4. Measure average next-month returns of equally-weighted SI and QI portfolios that are, respectively: (a) long LRHS stocks and short HRLS stocks; and, (b) long HRHS stocks and short LRLS stocks.
5. Measure average next-month return of an equally weighted portfolio that is long the SI portfolio and short the QI portfolio (Slow-Minus-Quick, SMQ).

They then examine whether limited investor attention or differences in news complexity and informativeness better explain results. Using firm-level news data, firm characteristics and associated stock returns for a broad sample of U.S. common stocks during 1979 through 2016, they find that: (more…)