I’m excited to announce that the book Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (hardcover, 288 pages, Wiley Finance) is now available.
In Quantitative Value, we make the case for quantitative value investment in stock selection and portfolio construction. Our rationale is that quantitative value investing assists us to defend against our own behavioral errors, and exploit the errors made by others. We examine in detail industry and academic research into a variety of fundamental value investing methods, and simple quantitative value investment strategies. We then independently backtest each method, and strategy, and combine the best into a new quantitative value investment model.
The book can be ordered from Wiley Finance, Amazon, or Barnes and Noble.
Look Inside
Overview
In Quantitative Value we begin our investigation by examining two simple quantitative value investment strategies: one suggested by the great value investor and philosopher Benjamin Graham, and the other Joel Greenblatt’s Magic Formula, and ask if there are simple ways to improve upon them.
We conduct our investigation along four broad lines:
- How to identify and avoid stocks at the highest risk of sustaining a permanent loss of capital, including those exhibiting financial statement manipulation, fraud, or financial distress (e.g. bankruptcy)
- How to find stocks of the highest quality, which we define as those possessing an economic franchise, and superior financial strength
- Which price ratios (e.g. price-to-book value or price-to-earnings) best identify undervalued stocks and lead to the best risk-adjusted investment performance? We look at several unusual implementations of price ratios, including long-term averages and combinations of price ratios
- Which signals sent by other market participants identify stocks primed for performance? We look at the impact of buybacks, insider purchases, short selling, and buying and selling from institutional investment managers and activists.
We examine the best way to structure our findings into a cohesive strategy, and then backtest the resulting quantitative value model. We compare the performance of our quantitative value model with the performance of several well-known value investing mutual funds.
The book can be ordered from Wiley Finance, Amazon, or Barnes and Noble.
What people are saying
Quantitative Value is a must-read for those with a love of value investing and a desire to make the investment process less ad-hoc.
—Tony Tang, PhD, Global Macro Researcher and Portfolio Manager, AQR Capital Management
If you liked The Little Book that Beats the Market, you will love Quantitative Value. Gray and Carlisle take systematic value-based investing to the next level.
—Raife Giovinazzo, PhD, CFA, Research Analyst in Scientific Active Equity, BlackRock, Inc.
Quantitative Value is the new guide to Graham-and-Doddsville. Gray and Carlisle synthesize the lessons of the great value investors to systematically identify high quality value stocks while avoiding common behavioral pitfalls.
—Tadas Viskanta, Founder and Editor, Abnormal Returns and author of Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere
Gray and Carlisle successfully bridge the gap between fundamental and quantitative value investing—an extremely worthy endeavor and, likewise, an extremely rewarding read.
—MacDuff Kuhnert, CFA, Quantitative Portfolio Manager, Causeway Capital Management LLC
Gray and Carlisle take you behind the curtains to build a black box based on the best value minds in finance. They combine academia’s best ideas with the ideas of Buffett, Graham, and Thorp, to develop a quant system that performs in markets both good and bad.
—Mebane Faber, author of The Ivy Portfolio, and Portfolio Manager for Cambria Investment Management, Inc.
A clear and concise vision of how the two dominant disciplines of modern investing (quant and value) can be combined in actionable ways that produce outsized returns over the market.
—Christopher Cole, CFA, Founder and Portfolio Manager, Artemis Capital Management LLC
An elegant synthesis of Warren Buffett’s value investment philosophy and Ed Thorp’s quantitative approach. Quantitative Value belongs on every investor’s bookshelf.
—Charles Mizrahi, Author of Getting Started in Value Investing and Editor of Hiddenvaluesalert.com
“We seek to marry Ed Thorp’s quantitative approach to Warren Buffett’s value investment philosophy.” That’s the approach we take in our Value Investing class at UC Davis and Quantitative Value will become required reading for our class. The book we wish we would have written!
—Lonnie J. Rush and Jacob L. Taylor, Managing Partners of Farnam Street Investments and Visiting Professors at UC Davis Graduate School of Management
The book can be ordered from Wiley Finance, Amazon, or Barnes and Noble.
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In his book, Joel Greenblatt mentions that if you DIY and don’t use his screener, you should use P/E. He also states “If a stock has a very low P/E ratio, say 5 or less, that may indicate that the previous year or the data being used are unusual in some way. You may want to eliminate these stocks from your list.”
Richard Tortoriello wrote “Quantitative Strategies for Achieving Alpha”. He gives possible stock screens. In his stock screens, he uses upper and lower limits on his ratios “to avoid outliers (unusual values that might indicate something other than an attractive valuation).” Outliers are the highest and lowest 5% of values.
It looks like neither Joel Greenblatt or Richard Tortoriello excluded outliers in generating the results they presented in their books.
Have you tested your method with and without excluding outliers? What is your opinion on excluding outliers?
We didn’t test it. It’s an interesting idea. We’ll put it through the system.
In your quantitative value strategy, you use EBIT/TEV. From 1974 to 2011, that metric outperforms the Magic Formula by 2.01%.
Early in the book, you discuss your Quality and Price strategy. The Q&P strategy is similar to the MF strategy, but substitutes BM for EBIT/TEV and GPA for ROC. From 1964 to 2011, Q&P outperformed MF by 2.52%.
Have you directly compared EBIT/TEV to Q&P and if so, what was the result?
Sorry this isn’t in the forum, but I started in this thread.
GP/TA adds to the performance of EBIT/TEV, but it still underperforms the full QV quality suite.
Have you tested your methods in nonUS stock markets?
I see that you’ve started a forum, and that my questions should have been directed there. You answered the above question in that forum.
Not yet. We’re working on it.
One comment I have seen on the internet is that those who have tried to implement quantitative value investing in the past have not been that successful. The examples given were funds associated with James O’Shaugnessy, David Dreman and Joel Greenblatt. It should be noted that no data was given to substantiate the comment. And I have seen data showing that DFA has had some success at the institutional level.
Nevertheless, quantitative value investing has had mixed success in the past. If you agree with that conclusion, I would appreciate your comments on why there has been mixed success.
There’s some support for that view since 2007 (Quant funds don’t perform like a good quant fund should):
Then there’s this research specifically comparing the performance of quantitative and qualitative hedge funds:
All the strategies cycle. Long periods of underperformance are often followed by better performance.
I have seen a video of a lecture that Joel Greenblatt gave to Columbia business students, in which he said that the Magic Formula has been tested for holding periods of 3 years, and it worked. David Dreman, in “Contrarian Investment Strategies” makes a case for holding periods of up to 5 years. Similarly, James Montier in ” Value Investing” provides data supporting holding periods of 4 years.
Multiyear holding periods may result in lower gross returns, but they are more tax and cost efficient. And my perception is that with holding periods of 2 or more years, momentum is not a significant issue.
Your book uses 1 year holding periods. I would appreciate your comments on longer holding periods.
You addressed this question in the forum also.
We’re working on it.
http://merlin.gsb.columbia.edu:8080/ramgen/video3/admin/alumni/Reunion_2006/Reunion_4-8-06_Greenblatt.rm
This is the link to the relevant Greenblatt lecture
Doesn’t seem to work for me. Is there another link?
Not that I know of. I just tried it, and it worked for me. You need Real Player.
Is there a higher level link that doesn’t connect directly to the video?
Sorry, can’t help you on that one. If you google search the above link, several websites have it.
http://www.gurufocus.com/news/59450/answers-from-joel-greenblatt-are-here
In question 22 of the above interview, Joel Greenblatt states that 2 and 3 year holding periods work also. He doesn’t go into detail.
Great. Thank you.
In your book, you don’t mention momentum. Momentum is not an easy strategy to implement. The extra costs associated with it can readily nullify any extra return. However, the combination of value and momentum has attractive features.
I have seen Larry Swedroe mention several times that DFA uses momentum. In this case, they don’t select stocks with positive momentum. Instead, they omit stocks with negative momentum; this makes it more cost and tax efficient.. If I remember correctly, they omit stocks with the worst 20% return.
Your comments on momentum, in regards to your book on quantitative value investing, are appreciated.
Hmm, I don’t know if momentum fits in a book called “Quantitative Value”. I’m a vanilla value guy. Maybe check out O’Shaughnessy’s book.
Thanks for all your responses. FWIW, I think the screen for negative momentum by DFA is for the worst 25%, not 20%. I agree with your comment about momentum and a book called “Quantitative Value”. Nevertheless, at a practical level, momentum operates independently from value and is of comparable size. For holding periods of less than 2 years, it is reasonable to consider it. Otherwise, there is the possibility that the return from value investing may be nullified by negative momentum.
Momentum is interesting. My concerns about it are twofold. One, I don’t get why it works, and two, I’m worried that there is some unknown relationship between QE and momentum. It seems to have broken down in the US since 2009, and it doesn’t seem to have worked in Japan since the data started 30 years ago. There is an AQR paper “Momentum in Japan The Exception that Proves the Rule” to the effect that the absence of momentum in Japan is not statistically significant. From the paper:
That might be some comfort, but if the relationship between QE and momentum does exist, and the Fed is going to be fois gras’ing QE down our necks until the debt is fully monetized, maybe momentum won’t work. I don’t really know enough to comment intelligently on it. Maybe someone with a better idea can comment.
My question related to using value composites, as opposed to single value metrics. The following comes from reviews of “What Works on Wall Street”.
http://seekingalpha.com/article/56715-book-review-what-works-on-wall-street
“he tests a number of strategies that should yield similar results. One of them will end up the best — the one that happened to fit the curiosities of history that are unlikely to repeat. (That’s one reason why I use a blend of value metrics when I do stock selection. I can’t tell which one will work the best.) The one that works the best just happens to be the victor of a large data-mining exercise. Also, when you test so many strategies, and possibly some that did not make it into the book, the odds that the best strategy was best due to a fluke of history rises.” 2007 review
http://www.muhlenkamp.com/investment/principles/review_of_what_works_on_wall_street
“on page 144, O’Shaughnessy prints tables showing the Compound Annual Rates of Return by Decade for the strategies of High & Low Price to Earnings, High & Low Price to Book, High & Low Price to Cash Flow, High & Low Price to Sales, and High Yield. A quick look shows that none of the strategies was optimal for two successive decades. In the large stock universe, the optimal strategy in the 1950s was low price to cash flow. In the 1960s, it was high price to cash flow. In the 1970s, it returned to low price to cash flow. Note that each decade’s optimal strategy is a reverse of the prior decade’s optimal strategy. Someone using a strategy derived from using O’Shaughnessy’s methods, based on his data, over a decade would have found their strategy to be backwards in the following decade. In chapter 14, O’Shaughnessy reviews Returns on Shareholder Equity. In his Implications (summary) on pages 182 and 187, he points out that high ROE was a very successful strategy from 1952 through 1967-successful enough to make someone using an O’Shaughnessy method a true believer, only to have the strategy not work in the 1970s.” 1997 review
Why am I mentioning reviews from What Works on Wall Street”. Because your book advocates single value metrics. In backtesting, a single value metric may work, but may not work in the next 10 years. A value composite may not be quite as successful as a single value metric in the next 10 years, but your chance of failing may be lower.
This question was not needed, as you answered it on page 158. “the EBIT enterprise multiple is the best performed over any rolling 5- or 10-year window.”
However, if you could go into more detail on the next 2 sentences on page 158, that would be appreciated. “In the first half of the sample, however, the composite ratios beat the EBIT enterprise multiple. Over the entire sample the EBIT enterprise multiple stands out.’
About Figures 8.4(a) and (b), might I suggest asking the printer to change the colors? Due to the colors, those figures are not easy to follow.
On page 182, you state “There is some weak evidence that composite price ratios outperformed on a rolling 5- and 10-year basis at the beginning of the sample, but little to indicate that any composite outperform the single-year EBIT enterprise multiple.”
I’m a little confused.
The EBIT/TEV works best over the full sample and on rolling 5- and 10-year bases. We tested it to the academic gold standard and couldn’t find anything better.
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Hi, I really enjoyed your book and had a few questions about it.
1) I noticed that the Graham strategy produced a higher CAGR than the QV strategy. If someone can invest long-term and doesn’t mind the volatility or care about Sharpe ratios, is using the Graham strategy a better choice?
2) Why do you eliminate only the top 5% when cleaning the stock universe of manipulators? Why 5% as opposed to 10% or some other number?
3) Is there a theoretical basis for the EBIT-Enterprise Value multiple performing the best? If not, isn’t testing all of the price ratios and selecting the best one just data snooping?
Hi Pat,
Thank you for the kind words. To answer your questions:
1) The Graham strategy was highly concentrated, sometimes holding just one stock. It’s not good idea to be concentrated into a single stock because if something bad happens to it your entire portfolio is goes where it goes (i.e. to zero or down 90 percent). There is important information in the Sharpe and Sortino ratios – even for value investors – but the concentration is the main issue. The return diminish if we select a maximum weighting for a single position in the portfolio.
2) We only eliminate the top 5% to leave a sufficiently large universe of stocks for our other examinations and portfolio construction. 10% would probably also be fine, although it would reduce the stocks available for those other examinations.
3) We can make a theoretical argument for the outperformance of EBIT-Enterprise Value multiple versus other single ratios: it contains a lot of information about what you pay and what you get. It also performs comparably to the EBITDA-EM, and to the long-term averages, suggesting that it’s quite robust. Your point about data snooping isn’t lost, however we tested the data using the very conservative assumptions outlined in the book, and then presented the results over different periods and in bull and bear markets, showing the results without fear or favor. One of the ratios was going to win.
Best,
Toby
[...] This is a test forum for Greenbackd suggested by commenters rational and ShadowStock (@JournalofValue) created initially to discuss the book Quantitative Value (http://greenbackd.com/2012/12/26/quantitative-value-a-practitioners-guide-to-automating-intelligent-…). [...]
I bought the hard copy before the Kindle edition was out, and really enjoyed it. I do however, have some follow up questions. is there a forum planned where readers may post their questions?
That’s a great idea. Let us see what we can figure out.
That was exactly my thought before your reply. A forum would create a dedicated loyal community that may expand, leverage and even challenge points made in the book. A small entrance fee may be appropriate. Thanks John
I’ve created a test forum at Greenbackd Forum and sent invitations to both of you. Once we’re satisfied that it works I’ll expand it to everyone.
I bought the hard copy. Some books I have bought in the past, I also buy the e-copy as I believe they have something special and are worth keeping in digital format. This is one such book and I will be buying the e-copy when it is available.
I must recommend this book to anyone who wants to know the facts and figures regarding what is successful in investing.
The book contains a fantastic amount of information and it somehow feels strange to get to the end and then go “oh it really is quite simple”. But that is it’s beauty.
Many people who do not invest their own money are used to living in the financial world with complexity and a language that obscures just actually how simple investing like Ben Graham can be and how it can generate outstanding returns.
The major message I took from the book is that despite all the supposed complexity of the financial markets and all those advisers using the “special” language which simply makes them appear smart without actually being so, investing is simple. But as Buffett said “simple but not easy”.
Have a plan/methodology (which the book provides), have some patience (being the desire not to jump at every piece of “noise”) and investment success, with a dash of luck should follow.
Steve
I actually purchased the hard copy and then when the e copy was available I purchased that as well. Expensive for me and the wife can’t understand my motives but “I believe they have something special and are worth keeping in digital format.”
I’m enjoying the kindle version more as I can highlight or tweet. So much valuable work went into this book!
John
OK. I’m off to Amazon. Yes my wife too checks the credit card to discover that I have bought the same book that I have in hard copy. I have argued successfully (well kind of) that having the highlighting function saves us dollars from not buying Post-it Notes to use as stickies..:). I cant bring myself to write in books.
Of course subscribing to half a dozen trashy women’s mags is different…
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Congrats to you and Wes on the book being published! I look forward to getting my hands on a copy!
Thank you.
My copy of Quantitative value arrived yesterday. I reluctantly chose not to wait for a kindle version that may never be coming.
I immediately jumped to chapters that looked particularly interesting. For example Ch11, “Problems with the magic formula”.
I’m absolutely floored by the original, useful information packed in this book. This book after only reading a few select chapters will or may be the best most practical useful book on value investing. I’ve read countless books on investing / value investing.
“Quantitative value” should be or I believe will be required reading for all MBA’s taking an advance class on investing. I’ve taken investment analysis and advance investment analysis at a school where one of the professors, well before I was a student, won the Nobel Prize in Economics. Yep that may be why I was brain washed on “modern portfolio theory”, CAPM, efficient frontier, capital market line and the math behind these theories. Okay at the time I didn’t realize it was a complete waste of practical investing information. Then it took effort and time to realize and admit real opportunities exist with inefficient markets. But the classes have given me a healthy respect for the market’s ability to adjust stock prices.
The book “Quantitative value” is the text book for the value investor practitioner or academic teaching a class on investing. I’m excited about reading/rereading more, and improving my own investing techniques or finding new overlooked approaches.
Wow. Thank you for the very kind words, John.
[...] Download Toby’s free chapter and read this article on eliminating behavioral errors: http://greenbackd.com/2012/12/26/quantitative-value-a-practitioners-guide-to-automating-intelligent-… [...]
[...] new book on quantitative value investing from the guy who runs the Greenbackd [...]
[...] Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Biase by Wesley Gray and Tobias Carlisle is now available. (Greenbackd) [...]
I’m ready to buy the book but if I can get a kindle version that would be perfect. Just checked Amazon but no kindle version. Thoughts, Thanks
[...] http://greenbackd.com/2012/12/26/quantitative-value-a-practitioners-guide-to-automating-intelligent-… [...]
Is an ebook version planned?
Ebook versions are out. I got mine on Kobobooks.com. If you have a Kindle, it is also out for that on Amazon. Short review, this book is awesome.
Oops, no Kindle version! But it is out on Kobo for epub ereaders.