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A recent article (pdf) in the Journal of Marketing studied the impact that third-party reviews (TPRs) of new products can have on stock prices.

Third party reviews (TPRs) are simply reviews by professionals and media that are independent of the sellers of the product.

The article studies the impact movie reviews had on the stock price of the parent company. The authors looked at movie releases in 2005-2006 and studied the critics' reviews from major newspapers and entertainment media.

The study covered films from 21 studios owned by the usual media suspects: Viacom (NASDAQ:VIA), Time Warner (NYSE:TWX), Disney (NYSE:DIS), Sony (NYSE:SNE), News Corp (NASDAQ:NWS), Lions Gate (NYSE:LGF), General Electric (NYSE:GE). It also examined the timing of the review, whether it was negative, positive or neutral, and other factors. To simplify the complex research methodology, the study was probing links between the critics' reviews and stock price.

Interestingly, the study also looked in depth at the relative quality of reviews (i.e., if they were more or less positive or negative than existing reviews). The authors probed for changes in the information and expectations about the film and quantified the results.

Summary of Findings:

While it is probably not a surprise to most investors that "John Carter" won't do much to boost Disney's stock price, the article had some potentially useful findings. The actual impact of TPRs on stock price is much more nuanced than simply bad reviews hurting stock prices and positive ones boosting prices.

The authors summarized their study findings as follows:

The goal of this research is to examine how TPRs of new products may influence firm valuation. We show that, during the pre-introduction stage, investors pay attention to professional reviews to update their expectations about product sales potential. This is a dynamic process, and an important consequence is that the influence of a particular TPR on firm value depends on how it differs from other, previously published reviews. The face value of a review does not matter much; a negative review may still influence investors positively as long as it offers a more positive evaluation than earlier reviews (i.e., it beats the expectations based on earlier reviews). This unique value of relative valence of TPR's is consistent with the more general observation that what moves the stock market is unexpected news that shifts expectations" (Chen, Liu, & Zhang, 2012, 131) (emphasis added).

So, interestingly, we see that another horrid review of "John Carter" is not likely to move the stock as much as, say, a markedly less horrid review that offers some glimmer of hope for the epic flop. And while the study used movies as a "research context," some of the same concepts and findings could apply to other contexts. Another cited study in the article--one by Tellis and Johnson (2007) -- for example, linked the technology product reviews of Walter Mossberg in the Wall Street Journal to changes in stock prices of firms.

Other key points the authors make include:

  1. the timing of the review can be important;
  2. the amount of existing information available about a product matters; and
  3. companies can also use advertising to impact the marketplace of ideas.

Third-party product reviews at or close to the release of a new product and those where there is less information about the product may have more impact on stock price. There could be some practical applications of these findings for investors.

For example, we might consider how a product review about a new car that has a high level of uncertainty (e.g., Chrysler's revived 2013 Dodge Dart) could be more impactful than a review about a very well-known product that has already been released (e.g., the 2012 Toyota Camry, the most popular car in the U.S.)

With the 2013 models rolling out, the auto sector may be a useful context for investors to test the third-party review research findings on their own.

Some TPR Takeaways for Individual Investors:

  • Look for Surprises in New Places With New Tools: Probing product reviews in the media could be another useful tool in the investor's toolbox. This is the key lesson. While most of Wall Street is looking at the same company data to predict possible earnings surprises, individual investor may want to brush up on the latest product reviews in the media and look for subtle changes in the tenor of product reviews.
  • Look for Friends in Low Places: To continue with the auto analogy, the research in the article tends to show a steady stream of positive or negative reviews does not tend to prompt changes in stock price; however, a surprisingly less negative review of an auto maker that has had a steady stream of negative reviews could provide the greatest upside. The darlings of the product reviewers have to live up to and even exceed already high expectations (like a company with a very high P/E ratio). In the auto market, there remains considerable room for upside TPR surprises in the big three: General Motors (NYSE:GM), Ford (NYSE:F), Chrysler/Fiat (OTCPK:FIATY). And this very positive TPR, for example, on the 2013 Ford Escape may bode well for that company.
  • Look at the Market for Expectations: Ford moving up on Consumer Reports overall brand rating from 10th place (2012 ranking) back to 5th place (its 2011 ranking) is probably more notable than Toyota (NYSE:TM) moving up from #3 (2012) to #1 or #2 next year. Also, Toyota and Honda (NYSE:HMC) have been perennial winners in reputable Consumer Reports auto ratings. But in 2012 Subaru (OTCPK:FUJHY) claimed the top spot and Mazda (OTCPK:MZDAY) was runner up for overall brands. Toyota took the bronze and Honda was fourth. These changes in rank indicate how firms may seek to boost or maintain product expectations in the future. This recent TPR desribes why the 2013 Honda Accord "MUST" be a hit and highlights the interplay of expectations, TPRs and overall firm value.
  • Advertising Matters : Marketing can also be a factor and act to leverage good TPRs or mitigate bad ones. More consumers watch the Super Bowl than read Consumer Reports after all. And this factor can tie in with timing and TPRs. The Toyota/Telsa electric RAV 4 is soon to be released, for example, and early TPRs (and advertising will be key) for this version of the popular model. Investors may see how the timing of the TPRs and the new product release date can highlight the importance of reviews -- because the investor and consumer do not have much information about the product.
  • Size Up The Dog in the Third Party Review Fight: Be aware that some products may be a very minor part of a company's overall revenue or profits. Honda's #1 push mower reviews in Consumer Reports (see, e.g., May, 2011) probably have less influence on stock price than its Edmunds #1 ranking for highest value retention among automakers (after five years). How Honda fares in mowers ( just 7% of sales) may not move the stock as much as a positive (or negative) surprise review in its bread and butter auto sector (81% or revenues).

Of course, looking at products for investment ideas is old hat to many investors. The popular investing literature of Phil Fisher recommends this hands on "scuttle butt" research, and Peter Lynch recommended new investors start looking for investment ideas at stores and in what their friends and family were buying.

And while consumers have long used third-party reviews to make buying decisions, now investors who understand these reviews in greater depth may be able to use them in making investment decisions.

Disclosure:

I am long F, DIS.

Source: Reviews You Can Use: Third-Party Product Reviews And Stock Price

Additional disclosure: I also own most of these stocks through broad-based index funds, sector etfs and mutual funds.