Using Amazon Stars to Find Market Stars

You’ve recently purchased a new vacuum cleaner on and are excited to try it out. Unfortunately, when you plug it in and flip the switch it sounds like a plane is landing in your living room and sends your cat up the curtains. To save another shopper from your misery, you write a one-star review and continue your search. A recent article in The Wall Street Journal suggests that these reviews may carry more weight than we think.

When approximately 6 million Amazon customer reviews (spanning from 2004 to 2015) were analyzed, a positive relationship was discovered between customer ratings and a company’s stock returns. Dr. Jiekun Huang (assistant professor of finance at the University of Illinois at Urbana-Champaign), who conducted the study, was surprised at the results. “The idea,” he says, “is that the cumulative power of consumer opinion, in the form of positive reviews, conveys information about consumer goods. When consumers view certain products favorably, it indicates higher product quality and value which predicts higher cash flows and, in turn, higher stock prices.” Among other things, the results showed that stocks associated with higher-rated products in one month outperformed those that received lower ratings in the following month to the tune of about 10% (when extrapolated over a year).

Dr. Huang is furthering his research to include variables such as advertising and a company’s profit margins. In the meantime, however, the results add to an existing body of research around the value of “serendipitous information”, or data that investors come across by chance.