University of Kentucky Study Finds Seeking Alpha Quant Ratings Beat The Market

Quant

Investment research and stock picks come from many places, but not all resources are created equal. Computer-driven strategies – the power of quantitative analysis and collecting and analyzing numerical data in a fraction of the time – offer investors the opportunity to instantly evaluate stocks to help avoid companies with poor fundamentals contributing to portfolio losses.

Dr. Russell Jame, a business and economics professor at the University of Kentucky, and his co-authors wrote an independent study that found that Seeking Alpha Quant Ratings “strongly predict” future returns based on multiple years of data. Dr. Jame and Ph.D. Candidate Yuling Guo from the Gatton College of Business and Economics at the University of Kentucky performed the empirical study that identified Seeking Alpha reports as containing “clear buy and sell signals” with useful information. This article will:

1. Examine key takeaways from the University of Kentucky study

2. Highlight a stock example to illustrate features of SA’s empirically tested Quant Ratings

3. Reveal how analysts that employed the SA quant grades had better performance

Dr. Russell Jame

Dr. Russell Jame is well-known for his research on mutual funds, hedge funds, accounting, and behavioral finance. His research has been featured in the Wall Street Journal, Bloomberg, and leading publications like the Journal of Finance. The University of Kentucky’s legacy is rooted in academic excellence, demonstrated by its regular listing in “top” and “best” ranking categories. Jame became interested in Seeking Alpha’s quant model, which applies proprietary algorithms highlighting securities based on collective attributes associated with higher returns. Like ranking academic institutions or employing academic grades to measure factors, Seeking Alpha’s quantitative analysis uses an unbiased, data-driven approach to highlight directional recommendations and ‘Strong Buy’ rated stock picks poised for long-term success.

University of Kentucky Study: SA Quant Rating Return Analysis

The University of Kentucky researchers collected and analyzed seven years of SA quant ratings, quant recommendations, and factor grades. The study team created equal-weighted and value-weighted portfolios of stocks by SA Quant Ratings and analyzed monthly returns from 2016-2022. SA Quant rating performance was measured by employing the capital asset pricing model (CAPM), and multi-factor models developed at the University of Chicago business school by Nobel Prize laureates Eugene Fama and Kenneth French, and one by finance researcher Mark Carhart, who built upon Fama and French’s work.

Each of the below factors is a variable that strongly relates to future return expectations: the more factors, the greater the accuracy in selecting stocks with the highest probability of success.

Like baking a cake, the right ingredients and measurements are critical to the outcome, which is why each of the above models builds off the other. By incorporating new variables, your accuracy in predicting future return outcomes improves. However, having more factors or “ingredients” does not make a model more accurate. The key is introducing the right factors for optimal results.

The basic CAPM model calculates your investment or portfolio return by factoring in the time value of money and market risk as measured by a stock’s volatility, aka beta. The Fama-French three-factor model (1993) adds size and value to the equation on top of risk, and the Carhart four-factor model (1997) incorporates momentum.

Seeking Alpha Factor Grades and Quant Ratings

Seeking Alpha Quant captures over 100 metrics for each stock, compared to sector peers, and grades them across five Factors: Value, Growth, Profitability, Momentum, and EPS Revisions. Value, Growth, and Profitability are key fundamental indicators for identifying mispriced securities, and Momentum and EPS Revisions address temporality. The Quant Rating is designed to be useful and actionable across different trading strategies and for both long-term and short-term investors. There are approximately 4,700 stocks in the SA quant universe, including just over 400 Strong Buys. The University of Kentucky study authors found a strong positive relation between SA Quant Ratings and over 100 characteristics identified as significant returns predictors in a study by an award-winning economist and two Yale scholars (Jensen, Kelly, and Pedersen or JKP). While the JKP characteristics did not include EPS revisions, one of five key factors driving SA Quant Ratings, SA Quant Ratings have had a profound positive impact on Seeking Alpha’s platform and contributors, according to the study.

SA Quant “Strong Buy” ratings vs. S&P 500

The University of Kentucky study findings align with the SA Quant Team’s backtested strategy. It has delivered impressive returns through powerful computer processing and its unique “quantamental” analysis, beating the S&P 500 for 12 out of the last 13 years.

The University of Kentucky researchers used the six-factor model by augmenting the Fama-French five-factor model (2015), which includes profitability and investment, with the Carhart momentum factor. In their study, the first row in the table below displays the raw monthly returns by SA quant rating for the equal-weighted portfolio. The next four lines represent the excess returns (i.e., alpha) according to each model. SA Strong Buy rated stocks in the equal-weighted portfolio posted an average monthly raw return of 1.92% (~25.6% annualized) during the seven years, generating significant excess returns according to the models.

The results found that average portfolio returns increased with the quantitative recommendation, underscoring the predictive strength of the SA Quant Ratings. The equal-weighted CAPM alpha increases from -1.17% for the strong sell portfolio to 0.81% for the strong buy portfolio. The difference in excess returns between the long and short portfolio of 1.99% is “economically large and statistically significant,” the researchers concluded. The value-weighted portfolio also showed strong predictive results, with Strong Buys returning 1.48%/month (~19.3% annualized) and excess returns ranging from 0.41%-0.56%/month. The authors noted that alphas were statistically significant even after making Quant Ratings publicly available on the SA platform.

Researchers also explained that SA Quant Ratings are related to academic measures of mispricing that also ‘strongly predict’ future returns. The author’s abstract summarizes the purpose of the study and conclusions:

We examine the impact of introducing quantitative ratings, which strongly predict returns, on the Seeking Alpha (SA) platform. After the change, we observe a 20-fold increase in the percentage of SA reports mentioning quant-related terms (Quant Reports). SA report recommendations also become more aligned with quant ratings. This effect is stronger for Quant Reports and reports authored by less quantitatively savvy contributors. Furthermore, both types of reports become significantly stronger predictors of future returns. We conclude that improved access to quantitative analysis enhances social media research, particularly for less sophisticated investors who likely had limited previous exposure to quantitative analysis.

Following the introduction of Quant Ratings on the SA platform in June 2019, the researchers observed a 20-fold increase in the percentage of SA reports mentioning quant-related terms (referred to as “Quant Reports” in the study). Seeking Alpha’s Quant Strong Buy rated stocks have significantly outperformed the market twelve out of the last 13 years, according to the backtest. The study found that as becoming more aligned with SA Quant Ratings, report recommendations became “significantly more informative” and more robust predictors of future returns. For example, a one-unit increase in SA report recommendations (i.e., moving from a Hold to a Buy) saw return increases of 1.85% over a 1-month horizon and 2.97% over a 3-month horizon. SA report recommendations also became significantly more correlated with ETF quant ratings after introducing the ratings on the SA platform in March of 2021.

Researchers concluded that the introduction of Quant Ratings offers “pronounced benefits” and SA research “may now be a force that attenuates anomaly mispricing.” The University of Kentucky study authors said SA contributors would benefit from regularly incorporating quantitative research in their analysis.

Similarly, consumers of SA research should, all else equal, gravitate towards reports that include some quantitative analysis, and other social media platforms may potentially benefit by providing their own versions of quantitative ratings.

The findings suggest modifications in platform design on social media sites could serve as a “potentially significant means of improving financial literacy.” On March 19, 2024, the Seeking Alpha Quant Team interviewed Professor Jame, who said his findings tend to be met with shock over the “really large” returns generated by SA’s quant system.

Professor Jame delivered the study’s findings to peers and scholars at multiple venues, including the University of Kentucky, the University of Illinois Chicago (UIC), and North Carolina State University. “The way academics are trained – we’re very skeptical of big alphas,” said Jame. “That’s a question I get in seminars a lot: ‘This is so good, then why aren’t people using it?’”

For illustrative purposes, Alphabet, the only Mag 7 with a “Strong Buy” SA Quant Rating, is up over 33% since the SA Quant Team recommended the stock on August 23, 2023, just over eight months ago, soundly beating the S&P 500 (+20%) during the same period.

Alphabet Inc. (GOOGL)

• Market Capitalization: $1.99T

• Quant Rating: Strong Buy

• Quant Sector Ranking (as of 4/12/24): 2 out of 238

• Quant Industry Ranking (as of 4/12/24): 1 out of 58

Alphabet, also known as Google, is near the top of SA quant-rated stocks in the Communication sector and #1 in the Interactive Media and Services industry with a Strong Buy rating of 4.93. Alphabet is up 47% in the past year, outperforming the S&P 500 and NASDAQ indexes. GOOGL’s 1Y price performance soundly beats the -4% median of quant-rated communication sector stocks, driving an ‘A-’ Momentum Factor Grade.

Alphabet’s other factor grades include an ‘A+’ in profitability, a ‘B’ in growth, a ‘B+’ in EPS revisions, and a ‘D’ in valuation. Alphabet factor grades have remained stable over the past six months, and the stock has had a ‘Strong Buy’ Quant Rating for all but one week since October 27, 2023, and for most of the past year.

Key metrics underlying GOOGL’s Profitability Factor Grade include a net income margin of 24%, more than 800% above the sector median of 2.65%. Alphabet also soundly outperforms the sector in EBIT margin (28%), EBITDA margin (32%), ROE (27%), ROTC (18%), and ROA (18%). Nearly all of GOOGL’s key profitability metrics are above its 5-year average.

GOOGL’s ‘B’ Growth Grade is driven by solid metrics, including EPS growth FWD of nearly 20%, EBITDA growth FWD of 12%, and forward EBIT growth at 14%. According to consensus estimates, Alphabet has 32 EPS up revisions in the past three months to 13 down revisions, with EPS projected to grow 17% in FY24. Alphabet has a ‘D’ in valuation, but its forward P/E Growth (PEG), a metric that carries much weight, is 1.35x and in line with the sector median of 1.39x.

Concluding Summary

Quantitative analysis, as demonstrated by the University of Kentucky findings and emphasized through Seeking Alpha’s Quant Ratings and Factor Grades, is a robust tool to equip investors with the optimal resources for making well-informed decisions. Dr. Jame and Ph.D. Candidate Yuling Guo from the Gatton College of Business and Economics at the University of Kentucky conducted an independent empirical study of SA Quant Ratings. No individual at Seeking Alpha was aware of the study’s existence when it was published. The study’s analysis indicates that Seeking Alpha analysts who integrated SA Quant recommendations into their investment research achieved better performance and concluded that SA Quant-Rated Strong Buys significantly outperformed the market, substantiating the accuracy and predictive capabilities of the Seeking Alpha Quant model. In addition to the Alphabet example, Seeking Alpha has many top rated stocks, or if you prefer a limited number of monthly ideas from the hundreds of top quant stocks, consider exploring Alpha Picks.