How “Foolish” Are Internet Investors?

We offer the first systematic evidence that stock recommendations published on the Internet move prices and trading volumes. We found that buy announcements for small-cap growth stocks published in the nightly performance recap of The Motley Fool's Rule Breaker Portfolio engender statistically significant abnormal returns. The effects were generally larger than those following secondhand buy recommendations published in the print media or after a stock purchase recommendation on the television program “Wall $treet Week. ” Our finding of unusual trading volume also provides evidence consistent with the hypothesis that The Motley Fool buy announcements are closely followed and acted on by Internet investors. An interesting body of financial research documents the effects of buy/sell advice published in the print and electronic media on the prices and trading volume of U.S. stocks. Abnormal stock returns of 1.1 percentage points, 2.35 pps, and 4.06 pps have been tied to stock recommendations given, respectively, on the television program “Wall Street Week,” in Business Week's “Inside Wall Street” column, and in the Wall Street Journal's “Dartboard” column. We offer the first systematic evidence that stock recommendations made on the Internet move prices and trading volumes. To test the power of Internet stock advice, we considered ramifications of online buy announcements for The Motley Fool's Rule Breaker Portfolio. The Motley Fool (TMF) states that it has 1.5 million daily readers, and the daily performance recaps for the Rule Breaker Portfolio are its most popular feature. On average, TMF small-capitalization buy announcements for the Rule Breaker Portfolio had statistically significant positive wealth effects on the announcement day (Day 0) of, depending on the estimation method, 3.36–3.72 pps. Cumulative abnormal returns over the entire event period (Day −1, Day +1) averaged a surprisingly high 6.08–6.87 pps and suggest that such announcements are more newsworthy than secondhand buy/sell recommendations, such as those published in Business Week and the Wall Street Journal. Corroborating evidence came from nonparametric estimates, but they tended to be somewhat smaller and of less statistical significance than the parametric results. Corroborating evidence of the effect of buy announcements also came from our finding of abnormal trading volume. Following the buy announcements of small-cap growth stocks, we found average abnormal trading volume on Day 0 to be 126.53 percent above the trading volume norms for these stocks predicted by the market model and for the entire event period, volume of 568.12 percent above norms. The small-cap growth stocks that benefited from TMF buy announcements also tended to rise significantly on the trading day before the announcement, as would be true if preannouncement leaks or front running were occurring. Taken as a whole, our evidence documents that TMF's widely followed buy announcements for the Rule Breaker Portfolio are acted upon by Internet investors. Buy announcements and stock advice in TMF move stock prices. These results are especially interesting in light of the TMF mission statement in the Web site's “Introduction,” which advises that “the whole point of Foolishness is to make your own decisions, sink or swim based on your own beliefs. ” In fact, however, TMF's online readers closely follow and act upon the stock trading advice they find there.