Posts like “Facebook’s Q4: Conference Call Tone Matters More Than Results” in the financial press suggest that earnings call tone is important. And, invariably, the tone of the call does come up during the post call commentary and analysis. Were executives overly positive in their comments? Did they mean what they said? Did analysts’ questions tend be more negative? Were executives overly cautious in the words they used? Did they express a higher level of uncertainty?
Is tone really that important? And if so, can it be measured and scaled?
Why might tone be important?
Analysts and investors are seeking an edge as to where a company is headed next. So, they focus not only on the numbers, but on the words the executives use in their introductory remarks and in the answers to analysts’ questions. Executives can unintentionally or even intentionally “tip their hand” and provide a clue as to the company’s direction.
But aside from making good CNBC commentary, is there a connection between tone and future company performance? Is it possible to detect tone without listening to the call?
Financial textual analysis has matured
Before the advent of natural language programming (NLP), text analytics and enhanced computing power, written transcripts and audio recordings were all analysts had to go on. There is only so much that the human mind can discern. Subtle shifts in tone and word usage can go unnoticed when listening and tone seems lost when reading transcripts of calls you didn’t have time to cover.
But now, new tools have emerged that can help. Going beyond simple sentiment, nuances in tone emerge when analyzed with advanced computational linguistics. A new academic field of inquiry developed, financial textual analysis, out of this ability to decompose earnings transcripts and financial documents into their most granular bits. Academic researchers were (and are) keen to determine if tone can presage future company performance.
Although academic researchers have always been interested in studying financial disclosures, it wasn’t until the early 2000’s that interest in financial textual analysis really took off. The bibliography of a survey of financial textual analysis shows the exponential growth in the number of studies starting in the early 2000’s. The authors attribute this growth to the application of “highly evolved” computational linguistics technologies to financial documents and enhanced computing power.
So, does tone matter? Simple answer is YES.
What do these academic studies conclude about tone? Can executives’ tone on earnings calls “tell” analysts something about future company performance?
It is beyond the scope of this post to survey the entire field of financial textual analysis. But we can say the answer is “yes,” tone matters. Here is a taste of what the academic literature has found:
We note that these studies tend to be sophisticated statistical studies that attempt to estimate the relationship between tone and company or market performance after controlling for other factors that may affect such performance (i.e. they tend to be more than simple correlation studies).
A study by Price, Doran, Peterson and Bliss finds that “conference call linguistic tone is a significant predictor of abnormal returns and trading volume.” The researchers further find that the Q&A portion of calls has an incrementally greater effect than the introductory portion, which is typically a duplication of the earnings press release. The study concludes that “conference call tone dominates earnings surprises over the sixty trading days following the call.”
Another study by Price with Blau and DeLisle finds a positive relation between companies’ stock returns and earning call tone. But the researchers go on to argue that tone can be subtle and that more sophisticated investors (e.g. short sellers) process the information differently than the average investor. Empirically they find that “short sellers target firms with simultaneous high earnings surprise and abnormally high management tone.”
Druz, Petzev, Wagner and Zeckhauser looked at changes in earnings call tone from quarter to quarter finding that higher negativity of executives’ tone “strongly predicts lower future earnings and greater uncertainty.” Interestingly, the researchers find that decreased negativity only “weakly predicts the opposite.”
Finally, Chen, Demers, and Lev’s research showed that the overall negative tone of earnings call Q&A increased as the morning progressed, dipped slightly after lunch and then rose again until the market close. They also found that the more negative the tone, the more negative the stock returns over the five trading hours after the call. Those negative stock returns associated with negative calls continued downward for up to 15 trading days.
So, it’s clear that “tone matters” and computational linguistics can detect it. Analysts, investors and the market react to the choice of words used by executives in their earnings calls. Investors need to factor this information into their trading strategies, but with care to consider external factors as well.
Our Boulder Earnings Call Tracker examines earnings call tone and provides our clients with highly relevant signals for sophisticated trading strategies, especially short sellers. On the flip side it provides CEOs and investor relations with unbiased metrics to improve their conference call performance.