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Ideas Farm: What music hits tell us about IPOs

Chart toppers vs market toppiness
Ideas Farm: What music hits tell us about IPOs
  • Music chart success might be random
  • Ergo, beware post-IPO rallies
  • Lots of idea-generating content

What makes a hit song? In 2006, a Columbia University doctoral student called Michael Salganik set out to answer that question. Or to quote directly from the study that followed: “How can success in cultural markets be at once strikingly distinct from average performance, and yet so hard to anticipate for profit-motivated experts armed with extensive market research?”

To do so, he and his colleagues came up with a clever experiment. They built a website of 48 songs by unknown artists, which users could save and then download to their own private library. The academics then randomly assigned 14,341 participants to either browse and rate songs in the library alone, or to one of eight virtual social worlds in which they could view information on how frequently each song had been downloaded by previous participants in their group.

Users, Salganik found, were more likely to download songs that others had already downloaded. But there was also no telling what made for a hit song. Each world ended up picking its own blockbuster hit, with little correlation to the quality of each song as determined by the solo browsers.

The creation of a blockbuster hit, the study concluded, was both socially conditioned and random.

In his excellent 2021 book on the history of venture capital, The Power Law, the writer Sebastian Mallaby cites Salganik’s experiment as an example of the role feedback effects and luck can play in commercial success. Repeat history again, and the Harry Potter series or Facebook might never have gone viral.

Similarly, the stock market can be prone to bouts of unpredictable collective enthusiasm. Since 2020, this has been most apparent in the meme stock phenomenon, in which armies of retail investors placed leveraged bets on beaten-up companies such as video game retailer Gamestop (US:GME) and cinema chain AMC Entertainment (US:AMC).

But there is also a meme-like quality about stock market debuts. In the first month after pricing their offer, companies that raised at least £100mn in premium market listings in London over the past decade went up by 7 per cent on average, and less than a third lost value. But an IC analysis of trading data suggests early performance has almost zero correlation with longer-term returns.

In fact, the same group of stocks has averaged an average annual negative total return of 12 per cent. Just a fifth can boast a positive average annual return of at least 10 per cent, a level that might be considered worth buying into on debut.

We should be careful not to extrapolate too much from this limited data sample or overemphasise the similarities of cultural and financial market network effects. We know, for example, that bankers, sponsors and company owners often seek to time floats for periods when investors are at their most optimistic. In the real world, pop fans also tend to gravitate to music by artists they already know.

The latter point can be true of investors who buy into new issues, too, which may help to explain the buzz around some listings. In those cases, the trend may be amplified by short-term traders.

Either way, investors would do well to remember that early performance has little to do with the quality of a new issue. While there is at least a tangible social benefit from buying and listening to chart toppers – in the form of collective enjoyment and recognition of shared experience – the stock market equivalent comes with a lot more pitfalls.

External links:

Experimental Study of Inequality and Unpredictability in an Artificial Cultural Market (Salganik, Dodds & Watts)

The Power Law (Mallaby)