Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (hardcover, 288 pages, Wiley Finance, 2012).
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.
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.