Investors both big and small tend to go over a companys financials before making the decisions to buy or sell. These fundamentals are a tried and true method to help guarantee gains, yet the rise of big data offers a promising new way for investors to find returns. Mining troves of data with computer programs in hopes of finding meaningful patterns and information could be the future of investing, according to some experts.
At the very least, big data can help call out fraudulent companies before they sucker in more investors.
Financial scientists at Deutsche Bank have developed a model to find worrying signs at publicly traded companies. By going through data filed with the Securities and Exchanges Commission, the banks believe they can determine which companies are using questionable or even fraudulent accounting methods.
Inside the Numbers
According to The Financial Times, Deutsche Bank uses a version of Benfords Law to find possible problems. Developed back in 1938 by physicist Frank Benford, this theory finds that in any large, random set of data, most numbers begins with the digit 1, followed by two, and then down to the least likely to appear, nine. Benfords Law can help find red flags in financial information, election results and other data sets.
Other companies are also utilizing data mining techniques to find fraud.
Its a tool, but an increasingly powerful tool. And the more data you get into the mix the more powerful it becomes, Steven Blum, a managing director at Control Risks consulting firm, told the Financial Times.
The Case of Enron
Such techniques could have helped expose a company like Enron before it finally collapsed in 2001. The energy company had long been using dubious accounting practices to turn real staggering losses into on-paper gains. These tricks duped investors and send share prices soaring even when the company was on very questionable footing.
While Enron took financial fraud to a whole new level amongst publicly-traded companies, their ultimate demise proved that even well-regarded companies could be covering up financial problems.
Effective use of big data could help ensure that fraud never reaches those heights again.
Investing Wisely
While big data is becoming an established way to find losers on Wall Street, it can also be used to predict broader trends.
A study by the Warwick Business School found that mining data from Google searches can help predict a decline in the market. Researchers found a historic link in the rise in searches related to business and politics and a decline in stock markets.
Unlike Deutsch Banks financially focused fraud detection methods, Google is more of a psychological indicator of how people are feeling. In theory, it can be like the canary in the coal mine used to predict an upcoming disaster.
Even a down market presents opportunities, according to financial expert Keith Springer. Thats why foreknowledge of a declining market can be so useful.
Too Much of a Good Thing
While the uses of big data have real potential, some large shortcomings can make the technology less useful than it appears to be. The problem, it turns out, is not that there isnt enough data to comb through. Its that the existing data is read in a way thats not useful.
Case studies conducted by the Harvard Business Review show that companies are investing hugely in big data. Companies regularly use the information gleaned from big data to guide their business decisions. The problem? These businesses dont understand how to manage big data. They dont know how to analyze it properly, and cant respond to any insights they gain with the correct changes.
That can also be a problem for investors who are looking for a silver bullet to prove if a company is a winner or if the market is dealing with an impending decline. Data is only as useful as the methods used to analyze it.
