Faculty Findings

Individual Investors: Proceed with Caution

By Mary Hamann

Finance Professors Robert Battalio and Rick Mendenhall recently published research showing that because small investors (those who trade fewer than 500 shares) rely on less sophisticated information when making stock decisions than investors making large trades, they are often less successful.

The professors discovered that small investors routinely base their decisions solely on how a company’s earnings announcements compare to last year’s earnings figures rather than taking into account current information presented in analysts’ forecasts. As Battalio explains, this may be because the individual investor doesn’t have access to the forecasts. “Small investors buy when companies’ names appear in the paper,” Battalio said. “When earnings are announced, small investors tend to be net buyers. Even if it’s really bad news.”

Interestingly, their study showed that because institutional investors rely on both earnings announcements and analysts’ forecasts, they will frequently sell stock during the three-day period following a positive earnings announcement. Professors Battalio and Mendenhall speculate that this may be because investors seek to take advantage of the small investors’ tendency to buy stock when good news is reported.

The professors’ advice to individual investors: don’t play the stock market. Mendenhall recommended buying index funds. “Concentrate on asset allocation, getting broad diversification,” he said.