Rating Last Week's Editors' Picks: A Purely Quantitative Perspective

by: William Matson, CFA


Powerful synergies can result from combining crowdsourced qualitative perspectives with quantitative screening.

Seeking Alpha articles – particularly Editors’ Picks – provide significant qualitative insight, and academic studies have shown that contributors’ recommendations have been, on average, associated with positive alpha.

This article provides ratings for the stocks discussed in last week’s Editors’ Picks, solely on the basis of quantitative characteristics that have historically been associated with superior returns.

These quantitative characteristics are largely responsible for the success of my personal trading portfolio, whose returns have been a well-documented 23.5% compounded annually during the past 16 years.

Last week’s bullish Editors’ Pick ranked highest by my quantitative ratings is Immucell. My ratings also buttress contributors’ bearish cases against Tesla, Solar City, and Allergan.


Powerful synergies can result from combining crowdsourced qualitative perspectives with quantitative screening. Seeking Alpha articles, particularly Editors' Picks, provide useful qualitative insight, and academic studies have shown that contributors' recommendations have been, on average, associated with positive alpha. Screening these recommendations for quantitative characteristics with strong historical track records is likely, I have found, to generate additional alpha.

My Rating Methodology

In selecting which stocks to buy and sell, I regularly rate several thousand stocks. I base my ratings on a variety of quantitative characteristics that have historically been associated with superior returns - during a 52-year backtesting period (1951-2002) and/or in my own portfolio since 2000.

My ratings range from 1 (least attractive decile to own) to 10 (most attractive decile). And the algorithms that generate them are primarily based upon the strategies described in Data Driven Investing, a book I co-authored that is available free in its entirety on Google Books.

At present, the variables in my algorithm (predictive of superior returns) are:

- high 12-month relative strength,

- high 3-month relative strength,

- low price/sales,

- low price/tangible book value

- low price/net income,

- low price/operating income, and

- positive working capital/market cap.

Each of these variables has a different weighting, which is subject to change depending on such factors as Fed policy, the presidential election cycle, and time of year. In addition, the weighting of some variables may change in the case of outliers.

As Exhibit 45 of Data Driven Investing points out, the Fed-Election Cycle significantly affects the relative performance of:

- high vs. low relative strength,

- value vs. growth, and

- small cap vs. large cap.

Generally speaking, falling interest rates predicted - and presidential campaign years have coincided with - stronger relative performance for riskier stocks (i.e. small cap growth with high relative strength). The great majority of the time, though, my preference is to own small cap value with high relative strength.

Note that market cap itself is not one of my variables. I prefer to factor it into my trading decisions through a manual, rather than automated, process. Furthermore, given that most investors prefer large cap names, I believe that my ratings will be more useful to them if I avoid skewing them in favor of small caps.

Though high 12-month and 3-month relative strength is typically predictive of higher returns, this pattern tends to change in the last week of December, due to tax loss selling. Not only does the price directionality associated with high relative strength reverse itself, but I accord variables associated with low relative strength disproportionately large weightings. The logic behind this is that there are likely to be unrealized losses associated with low 12-month relative strength stocks, and very low 1-month relative strength is likely to reflect significant selling that is motivated by tax considerations. When this selling pressure is removed, these stocks tend to rebound.

The working capital/price metric is given additional weight when it is strongly negative. Such ratios are often predictive of impending loan covenant violations, if not bankruptcy.

If a contributor recommends that a stock be bought and I give it a 1, that doesn't necessarily mean that I disagree with him or her. All it means is that the stock is not attractive to value oriented investors like me who favor strong balance sheets and high relative strength. Truth be told, I almost never buy at stocks' bottoms or sell at their tops.

Also, be aware that some Editors' Picks may not be in my coverage universe. For the most part, I avoid commercial banks, thrifts, and insurers. And I generally ignore companies with no sales, as well as those for which I have only stale or incomplete financial data. This week's coverage universe included 3233 stocks.

Past Performance

Data Driven Investing fully documents - with Fidelity statements - my returns between July 2000 and March 2004. I intend to publish my returns for the past 16 years (23.5% compounded annually), with brokerage statements to document them. (Fidelity and TD Ameritrade have already given me permission to do this. I'm optimistic that the other firm I dealt with will follow suit shortly.)

Though my quantitative analysis has undoubtedly been responsible for the bulk of these returns, a variety of other analyses and tactics also added alpha. Please also bear in mind that past performance does not guarantee future performance.

Last Week's Editors' Picks & Their Ratings

Without further ado, here are my quantitative ratings and comments for the companies highlighted in last week's Editors' Picks:

MarineMax: A Rising Tide Does Not Lift All Boats (NYSE:HZO)

6 - Strong value metrics largely offset by poor relative strength.

Many Growth Catalysts For Pacira (NASDAQ:PCRX)

1 - Strong balance sheet, but weak value metrics and poor relative strength.

Alliance Holdings GP: Leading The Coal Industry Forward (NASDAQ:AHGP)

4 - Strong value metrics, but poor relative strength.

Tesla-SolarCity: A Lesson From Brexit (NASDAQ:TSLA) and (NASDAQ:SCTY)

Tesla: Bullets Out Of A Machine Gun

Potential SolarCity-Tesla Pairing Should Terrify Traditional Electric Utilities

Tesla And SolarCity, Or The Undoing Of Musk-Style Capitalism

Tesla And SolarCity: 2 'Wildcard' Scenarios

The Key To The Tesla/SolarCity Merger

Tesla Betrays Its Loyal Believers With SolarCity Embarrassment

Tesla Model X Sales Soar (Literally), While Cash Crashes

Volvo Undercuts Tesla's Autopilot Price By Almost 50%

Tesla, SpaceX, And The Model 3 Production Ramp

TSLA - 2 - Below average relative strength, terrible value metrics, slightly negative working capital.

SCTY - 1 - Horrendous on all counts. Out of 3233 stocks, it ranked 3175 overall.

Carrols: On Sale At 40% Discount To Peers Despite Unique Model Driving 25%+ Annual Growth (NASDAQ:TAST)

6 - Mixed bag: Strong 12-month but weak 3-month relative strength, strong operating income relative to price (but largely consumed by interest expense). Working capital and tangible book value are negative.

ImmuCell Corporation: A Cheap Biotech With Upcoming FDA Approval Catalyst (NASDAQ:ICCC)

9 - Average relative strength, very strong profitability relative to price, strong balance sheet. Price/tangible net worth is very low for a biotech.

Blue Buffalo: Priced For Perfection, Poised For Decline (NASDAQ:BUFF)

3 - Average relative strength, profitability and tangible net worth are expensive relative to price.

Gilead's Multi-Indication Pipeline Antibody GS-5745: Analysis (NASDAQ:GILD)

3 - Below average relative strength, strong profitability but low tangible net worth relative to price.

Symantec - Has The Alarm Clock Finally Rung Loudly Enough? (NASDAQ:SYMC)

3 - Below average relative strength, strong profitability but low tangible net worth relative to price.

AMD And 3 Other Case Studies In Tech Business Decline (NASDAQ:AMD)

8 - Extremely strong relative strength, but well below average on all value metrics other than price to sales. Strong working capital position.

Intel: ARM Servers To Renew Their Attack (NASDAQ:INTC)

7 - Strong profitability relative to price and solid working capital position. Roughly, average in other respects.

A Valeant Effort: How Allergan Used Acquisition Accounting To Inflate Sales Growth, Boost NOLs, And Reinvent The Operating Profitability Of Actavis Generics (NYSE:AGN)

1 - Well below average relative strength. Weak profitability relative to price.

Regeneron Generates Negative Alpha: Buy, Sell Or Hold? (NASDAQ:REGN)

2 - Below average relative strength. Weak profitability relative to price.

Long Clear Channel Outdoor: Sohn Investment Idea Contest Entry (NYSE:CCO)

3 - Poor 12-month but very strong 3-month relative strength. Large negative book value relative to price, despite inclusion of substantial intangibles. Deserves a lower rating than 3 because reported profitability has been enhanced by non-recurring items.

Ascent Capital: An Impending Zero As Debt Maturities Loom And Attrition Rates Spike (NASDAQ:ASCMA)

2 - Poor 12-month but strong 3-month relative strength. Huge negative tangible book value relative to price, but the company would be a bargain if economic value of intangible assets were anywhere near the balance sheet figure - the article's thesis is that they're not. Strong operating income relative to price, but not nearly enough to cover interest expense. Though the company has reported positive working capital, its upcoming debt maturities are likely, in the near future, to send this metric into negative territory.

In Conclusion

You get out of investing what you put into it. Though screening tools like mine do have a long history of identifying portfolios that subsequently generate significant alpha, additional alpha will be left on the table if one fails to look for information that these tools fail to capture.

In particular, maximization of alpha requires the discernment of recurring from non-recurring items. Also, note that GAAP accounting figures are, of necessity, imprecise communicators. If, as in the case of ASCMA, a debt maturity comes due slightly after the cutoff between current and long-term liabilities, it will be indistinguishable from a maturity 10 years off.

For best results, it pays to take a hard look at financial statements - including the footnotes - before acting upon my ratings. But if one's time or abilities don't permit this, there is good reason to believe that constructing diversified portfolios solely on the basis of these ratings might still allow one to generate significant alpha.

However, given the availability of quality crowdsourced research (e.g. through Seeking Alpha), there is no reason to be at the mercy of GAAP. In my opinion, the most efficient and effective path for small investors is to use my ratings as a means of screening this research and then rely upon Seeking Alpha contributors to uncover the qualitative considerations that GAAP fails to capture.

Again, despite my track record and Seeking Alpha contributors' history of generating alpha, it bears repeating that past performance is no guarantee of future performance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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