Behavioral finance research documents that investors are more likely to hold “attention grabbing” stocks — those of firms that currently have popular products and services. This tendency is known as “investor recognition,” and we show that it is an important determinant of security prices.
Our results indicate that investor recognition is about as important as fundamentals in explaining annual stock returns. Our results also show that investor recognition is an important factor in allocating resources in market economies.
These results vindicate the significant resources that companies allocate to investor relations and investment banking activities in order to promote their security offerings. To the extent that such activities are successful in increasing investor recognition, they should result in higher stock prices and lower costs of capital.
Our research is related to research on the role of investor sentiment in the stock market, which demonstrates that stock prices are affected by waves of investor sentiment, with certain stocks being more affected by sentiment than others. It seems likely that investor sentiment is an important determinant of investor recognition. The “dot-com bubble” of the late 1990s was an example of investor sentiment affecting investor recognition. Other influences can include index membership, exchange listing and analyst coverage.
Our results suggest that the analysis and forecasting of investor recognition is of similar importance to the analysis and forecasting of fundamentals in predicting stock price movements over short horizons. “Growth” investors may benefit from this, since they select securities with a primary focus on growth potential.