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Simple sounds make for sound investments

May 30, 2006 By Mark Peplow This article courtesy of Nature News.

Easily pronounced stocks do better on the market.

For those of you struggling to pick a winner in the complex world of stocks and shares, help is at hand. A psychology study has found that, at least in the short-term, stocks with names that are easier to pronounce consistently outperform those with more confusing monikers.

According to Adam Alter and Daniel Oppenheimer, psychologists at Princeton University, New Jersey, it's all about fluency. When people try to understand complicated information, they tend to focus on the simplest parts. This means that people naturally favour things that are more fluent, and easier to think about.

To test whether this behaviour influences what people buy on the stock market, the duo asked a group of ten undergraduates to rate the fluency of 60 fictional stock names, according to how difficult they were to pronounce. Companies such as 'Hillard' or 'Barning' were judged fluent, whereas 'Xagibdan' and 'Creaumy' were classed as complex names.

A second group were then asked how they thought each of the stocks would perform. Perhaps unsurprisingly, they tipped the nicely named stocks for success.

Taking stock

So far, so what, you might say; these were fictional stocks picked by undergraduates with no stake in the matter and nothing much to judge the companies by. But the scientists argue that this roughly simulates the launch of completely new shares on to the market, when investors are unlikely to have much information about the company beyond its name, which could consequently become an influential factor.

To check, Alter and Oppenheimer did a second study looking at 89 real stocks that were traded on the New York exchange between 1990 and 2004. They asked 16 undergraduates to grade the fluency of the stock names on a sliding scale. Then they checked on the stocks' performance.

As anticipated, the more complex a share's name, the poorer it performed on the first day of trading. The effect appeared to wane as time went on; after 6 months, when more information about the stock was presumably available, the name alone couldn't be used to predict a single stock's performance.

But the overall impact on a portfolio of stocks was, in this case at least, substantial. Alter and Oppenheimer calculated how much a US$1,000 investment would have fared if it were invested in either the ten most fluent, or ten least fluent, shares. After just one day, the fluent portfolio was $118 ahead of the tongue-twisters; and after a year, it was US$333 up.

"It's a very large effect," says Oppenheimer, who reports the work in the Proceedings of the National Academy of Sciences1. But so far the researchers have only trialled one bunch of stocks, so it is unclear how robust this trend really is. "I'd caution people not to change their portfolio on this basis."

Shares pronounced up

One explanation might be that bigger companies simply have more marketing people to dream up a catchy title, or certain business sectors may naturally tend towards simpler, more pronounceable names. But after a thorough statistical analysis, the psychologists concluded that there was no link between a company's type or size and its stock performance.

To prove the point, the pair finally analysed how well companies performed on the basis of their three-letter stock ticker code, which a company doesn't determine itself. Amazingly, pronounceable codes such as KAR still tended to do much better than unpronounceable ones such as RDO. Once again, the pair invested their fictitious $1,000, and found that the fluent codes were $85 up on the first day, although the portfolio was just $20 ahead after a year.

Oppenheimer says that considering psychological factors such as name choices could help to improve economic models. Because shares are traded by human beings, he reasons, behavioural foibles will undoubtedly influence how the market works.

It sounds like a winning formula, but are Alter and Oppenheimer ready to bet the farm on snappy-sounding stocks? "No," says Oppenheimer. "I don't have the money to invest."

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  1. Alter A. L.& Oppenheimer D. M. . Proc. Natl Acad. Sci, doi:10.1073/pnas.0601071103 (2006).


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