Social media gives investors a leg up

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Free advice may be worth more than the price, at least if you know where to look. A new study has found that the user-generated content on the social media site Seeking Alpha can be strongly predictive of future stock returns and earnings surprises, The Wall Street Journal Venture Capital Dispatch blog reported on Tuesday.

The study, “Wisdom of crowds: The value of stock opinions transmitted through social media,” analyzed more than 97,000 articles on individual stocks. Comments posted on the first two days of publication also were analyzed.

Rather than look for positive words, the researchers combed the content for negative words, which apparently appear less ambiguous than the positives. For example, the study cites the phrase “not perfect.”

They observed that a number of negative words in the original post and subsequent comments were negatively predictive of stock returns over several time frames: three months, six months, one year and three years.

What does this mean for investors?

The investing field is sharply tilted against the individual investor, but the little guy may be able to find some advantages on Seeking Alpha and perhaps similar social media sites. The study was not underwritten or paid for in any way by the Seeking Alpha website, by the way.

“For individual investors, (Seeking Alpha) is a very useful source for forming their investment strategies, particularly their alpha strategies,” says Yu Jeffrey Hu, associate professor at Georgia Institute of Technology’s Scheller College of Business and co-author of the paper.

“However, individual investors also need to be careful. They should consider the track record of the (Seeking Alpha) authors as well as the comments posted in response to articles (on the site), which contains useful information, as our study has shown,” he says.

Follow the crowd

The cream tends to rise to the top in terms of authors. Readers vote by following consistent and credible authors. But the comments on less credible stories provide value as well, the researchers found.

When commenters expressed dissent with less consistent or credible Seeking Alpha authors, the comments proved to have some forecasting value. In general, the tone of the comments was the most predictive.

“One way you can think about our finding is … assume there are two articles with an overall positive tone, but the first article receives positive comments and the second article receives negative comments. The former, generally, outperforms the latter,” says Byoung-Hyoun Hwang, assistant professor of finance at Purdue University, Krannert School of Management and a co-author of the study.

Sometimes following the herd, or a herd anyway, can pay off. Do you get investing tips or ideas from social media?

Social media isn’t all about free investing tips. Read about the dark side in 3 financial dangers of social media.

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Follow me on Twitter: @SheynaSteiner.

Senior investing reporter Sheyna Steiner is a co-author of “Future Millionaires’ Guidebook,” an e-book written by Bankrate editors and reporters. It’s available at all the major e-book retailers.