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One way that natural language processing can increase returns

ReportsCompanies that are quicker to file their financial reports will see more significant share price increases than those that report after a lag, research into the use of ‘natural language processing’ (NLP) has shown.

The researchers found that annual and quarterly reports that were subject to a “reporting lag” – even if only a few days – tended to be linked with more negative phrasing throughout the report and with a lower level of similarity to the previous report by the same company.

A connection to future stock returns was found, with slower-filing companies shown to “measurably underperform” those that filed promptly.

One possible explanation according to Karim Bannouh, senior European equity portfolio manager at NN Investment Partners (NNIP), is that making changes to a report takes time, especially if a company is trying to manipulate how it is perceived or highlight certain elements.

NNIP carried out the research along with Bas Peeters, visiting fellow at the Vrije Universiteit Amsterdam.

NLP techniques were used to calculate the tone of a report’s text and the changes between sequential quarterly and annual reports from the same company, and this was seen to have predictive power for future stock returns.

Another possible reason is that faster-filing companies are ones that can process information more quickly and efficiently, which has positive implications for business operations.

“The timeliness of submission could be a proxy for the company’s efficiency,” added Bannouh. “There’s less congestion in firms that can process information more rapidly.”

Size of the company is not a factor. Derek Geng, data scientist at NN IP, said: “We’ve frequently encountered the assumption that our findings could be attributable to a size bias. This is because larger companies usually have more human capital and therefore process information more quickly. But even if we analyse large-cap and small-cap universes separately, we find that firms that file faster enjoy significantly higher stock returns than slower-filing companies.”

NN IP’s European Equity team is already making use of the finding and also argues that the research points to new possibilities for incorporating sentiment analysis and NLP into investment decisions, including environmental, social and governance factors, as these areas are “more subjective and harder to quantify”.

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