Access to corporate earnings and company information has never been easier. However, a Michigan State University Broad College of Business researcher found that investors of U.S. companies with global operations aren’t paying enough attention to foreign stock information. In addition, many times these investors do not understand the information.
Because of this, companies may be undervalued or overvalued. Investors could form a trading strategy to take advantage of the misvaluation to gain returns.
A trading strategy that exploits this could generate as much as 10 percent in annual returns.
“When media is reporting information, and it is clear what that information means, investors can respond immediately, and the stock price would exhibit a sharp jump to the new level,” said Xing Huang, assistant professor of finance at the Broad College. “A slow response to information means that investing or selling of stocks is delayed by most investors.”
For companies, the responses can be crucial during a time when leadership may want to issue more stock shares to finance projects—a time when fair price is critical.
Good information unavailable or unknown could mean the market value will not be reflective and the firm could be undervalued. And, if the company waits until the market adjusts to the fair value, the opportunity may be gone.
In her paper, “Thinking Outside the Borders: Investors’ Under-Reaction to Foreign Operations Information,” accepted at the Review of Financial Studies, she tries to raise awareness of the issue.
For example, if a company has operations in China and the UK—positive news from China can increase the value of corporate stocks, while negative news can decrease the value. However, an investor in the West may not be able to keep on top of that information, Huang explained.
To work through these difficulties, Huang has come up with a trading strategy to that sets up proxies—acting as information that uses corporations’ annual report sales from its locations around the world, and industry average returns in the corresponding foreign countries. It is put into a formula for measuring overall foreign information, something that is understood by investors.
Specifically, if an auto company, for example, earns 20 percent of its sales from the UK, and is earning 30 percent of its sales from China, the percentages can be used to weight the auto industry return in the UK and China—to determine the overall foreign information. This can be used to set a trading strategy to buy firms with good foreign information and sell the firms with bad foreign information.
“There’s so much information from firms on the Internet today, but surprisingly we still find effects on the stocks from investors not paying attention to this information,” Huang said. “I want to raise awareness of this issue.”
Better information and easier access to the information means a quicker response time in stock prices, she explained.
“My research provides guidance to multinational firms on ways to facilitate information processing and achieve a fair price when financing globally,” she said.