This is a book that gets everything right in broad, but is too insistent on the details. How should you approach value investing from a purely quantitative standpoint? Easy:
- Screen out stocks that have relatively high accruals
- Avoid companies that may go bankrupt
- Margin of safety: choose companies with strong balance sheets and profits
- Look for long-term strength in profits.
- Buy them cheap.
- Buy when informed investors are buying.
But here’s the problem. Like the book What Works on Wall Street, Quantitative Value suffers from over-optimization. You pass through the data too many times, and you show great returns from the past, should someone have done it that way. But how much of the result is signal, and how much is an accident?
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The broad principles are unavoidably true. Even the measure of quality, Gross Profits as a fraction of Assets, was new to me, but when I read it, I realized that it was a proxy for having a moat, a sustainable competitive advantage. I added it to my screening framework.
With all of that said, I have simple advice to the readers. Follow the broad outlines of what the book teaches, but don’t follow it in detail. It is good to own companies that are sound, cheap, and improving.
I would also add this: use quantitative screening and scoring as a first step. I often note that companies that score well in my screens have accounting issues. So, be wary, and realize that value investing primarily means having a margin of safety. I.e., you won’t lose much if you are wrong. Purely quantitative value investing can be improved through company and industry knowledge.
Who would benefit from this book: Amateur value investors will benefit from this book; if the reader does not want to put the effort into learning value investing, this book will be of no use to him. If you want to, you can buy it here: Quantitative Value, + Web Site: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors.
Full disclosure: The publisher sent me a copy of the book for free.
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By David Merkel, CFA of Aleph Blog