Quantitative Value Investing Lecture Video; Cartoon Book on Why an Economy Grows

Quantitative Value Investing

Money Ball: To get into the mood of quantitative analysis view these short videos on baseball: http://www.youtube.com/watch?v=xn7C6jgl0RI and http://www.youtube.com/watch?v=emwkhGjTWcY

Quant Value Investing: http://greenbackd.com/2012/08/31/presentation-to-uc-davis-mba-value-investing-class-on-quantitative-value-investing/

Also go to www.greenbackd.com

Why an Economy Grows

Thanks to a reader for this cartoon book on how-an-economy-grows

Third Avenue Fund 3Q Letter:TAVF_3Q_2012 Letter


11 responses to “Quantitative Value Investing Lecture Video; Cartoon Book on Why an Economy Grows

  1. So, just buy low EV/EBITDA stocks, and play golf for the rest of the day. And magic Formula stocks are not so magical that they return over 30% pa.

    Taking a quick look at Google, I see that Bruce Berkowitz’s Fairholme Fund returned 98.0% over 10 years, compared with the S&P500 of 58.1% over the same period. That looks impressive (“nearly double the returns”, if I wanted to use market-speak), until you work out that that’s an outperformance of 2.3% pa. It’s anyone’s guess as to whether there’s actually any genuine alpha in there, or whether he bought a lot of risky stocks (for example, the banks) and just happened to have gotten lucky. I imagine that anyone simply buying a basket of low EV/EBITDA stocks and rotating them annually is likely to be able to match that performance. It just goes to show how ferociously difficult it is to beat the market.

  2. Third Ave’s quarterly letter is pretty good – they really dig deep into the philosophy behind some of those investments, especially regarding book value of the holding companies as a measure of value. Thanks for posting it. They definitely run a top notch shop.

    • TAVF is definitely a way to study net asset value investing. Typically they buy overcapitalized companies at a discount to their net asset values.

      However, Marty got crushed buying Mortgage Insurance company because the liabilities swamped the assets. Not much net asset value in a credit/banking crisis/housing crisis.

  3. I feel better about my own (disastrous) efforts to outperform FNSAX by cherry-picking from the Magic Formula screener if Greenblatt himself said he wasn’t good at it either.

    The video is making me reconsider my own portfolio strategy. I’d been working towards 5% each into 20 stocks I think are compounding machines at fair valuations. And maybe as I improved, I’d one day get that down to 5-8 positions.

    Now I’m wondering whether I shouldn’t carve out part of my assets first and divide them over simple, quantitative value methods instead (net net, Magic Formula, P/E<7 DE<.5) with no interference by yours truly.

    At least that way the WHOLE PORTFOLIO wouldn't be exposed to my behavioral biases. Food for thought…

    • Danger, though. I ran a paper portfolio about a year ago using a pretty similar strategy. It actually performed very badly. It seems to suffer the same flaws as that I’ve been reading on newsgroups about the Magic Formula; namely, that you do pick up a lot of scammy/vulnerable stocks. That has a very bad effect on performance.

      Interestingly, PE<7, DE<0.5 is what I refer to as the Dorfman Robot, after investor John Dorfman. In the early 2000's, it performed spectacularly, and then performance slackened off.

      I had read that someone had experimented with the DE<0.5, and it seems that dropping it would have produced even better returns. I've thought about this, and I think it depends very much where you are in the credit cycle. In credit expansion, it pays to load up on debt and shoot for the moon. If you get dislocation in the credit market, like we did in 2008, then watch out!
      My reservations about Magic Formula is that you get "cheap", but you don't necessarily get "good". Far too much of it is junk, and hurtful for performance. It's also unclear as to whether the ROC is a beneficial measure. The Turnkey Analysts seems to conclude that EV/EBITDA is pretty much the best metric their is (Although I think they used "TEV/EBIT", or something. It's close, though).
      One idea I've been toying with is to look for a much better measure of "good". That way is to use Ben Graham's ideas on stable earnings: look for companies that have doubled EPS over the last decade, and have had at most 2 drops in EPS of 5% or more. Rank according to EV/EBITDA, and see what you get. Doing this mechanically allows you to spot candidates quickly, and weed out any anomolies that arise.
      I think you get much better candidates for quality that way, which, combined with cheapness, tends to reduce downside risk whilst giving greater upside potential.
      Just some ideas to play with.

      • Thanks for the tips, Mcturra. In your paper portfolio were you using a handful of RELATIVELY UNCORRELATED value strategies, or just a handful of value strategies?

        For example, if I used something like:
        20% Net-Nets
        20% Magic Formula Large Caps
        20% Buffett Growth (i.e. compounding machines at good prices)
        20% P/E < 7, D/E < 0.5
        20% Cheapest global ETFs by Shiller P/E

        It would SEEM like the strategies would be selecting from different enough universes such that the majority wouldn't all go bad at the same time.

        Wish I had the database to verify what would've happened with that in 2008. 🙂

        • One year I selected 6 or 7 lowest PE stocks that had an acceptable “Graham Gearing”. GG is calculated as:
          100 x (Shareholders Funds-Minorities-Prefs) / (Fixed Assets + Current Assets)

          In the words of Ben Graham: “I favor this simple rule: A company should own at least twice what it owes. An easy way to check on that is to look at the ratio of stockholders’ equity to total assets, if the ratio is at least 50%, the company’s financial condition can be considered sound.”

          The results were terrible. In the subsequent year, I kept it simpler and went for cheap PE with a Z-score of at least 3.

          Again, the results were terrible. They seems to have a knack of picking up some really dubious companies despite the supposed then-current strong financial position.

          Talking of 2008 … quite some time ago now I checked on the portfolio that a reader of the Motley Fool came up with in about March 2009. He was an experienced investor, and he probably sensed that the market had about bottomed out, hence the timing of announcing the specimen portfolio. Looking back, the companies were terrible, and subsequently a large percentage went bust, or were taken out. It was difficult to keep track of them entirely. However, if memory serves, if you had held for a year, you would have substantially outperformed the index. People were referring to him as a genius investor.

          Be warned, though, that I think the mid- and long- term performance was probably bad. Very bad. Worse than very bad. I think it’s like John said, with some strategies, you have to understand the exact game you’re playing and the exact rules of the particular game, otherwise you’re going to get burnt.

          On a semi-related note: I was reviewing John’s post on excellent investments:
          and came across an article “The Growth vs. Value Debate — Depends on the Holding Period” http://is.gd/G9F5MX
          which I think people will find of interest.

          • Just a final follow-up, Mcturra.

            I was reading through The Guru Investor book last night, where the guy has something like 10 different screens to approximate various guru’s strategies (Piotroski, Graham, Greenblatt, etc.) as much as can be done via a purely mechanical selection process.

            The question comes up as to whether you should go for DIVERSITY by equal-weighting multiple uncorrelated strategies as I mentioned above, or CONSENSUS by picking, say, AAPL because it’s passing 7 out of your 10 screens.

            He seemed to say that if pure maximum return is your aim, go for a consensus approach. But if maximum risk-adjusted return (highest Sharpe ratio) is what you’re after, and you’d like less volatility, then go for the diversity of uncorrelated strategies.

  4. Perhaps you can really analyze your behavioral biases and build firewalls around them to help make the proper decisions. This gets back to an investment philosophy. One of the best investors I know–a private investor, ex-lawyer spent over a year refining his inv. phil.

    • John, how did that investor do that?

      I think the problem is that you often end up with a “yes but, no but, yes but” quandary. Should you trade “with” the information flow, or “against” it? It’s difficult to know.

      Within the last month, I was reading about a day trader, who was giving advice on investment journals. The purpose of the exercise is, ultimately, to identify highly successful trading scenarios.

      It then dawned on me. Successful investing is not so much about psychology, but in identifying successful investment setups. Of course, we wont be focussing on day trading and charts, but on business characteristics and events. When you know why you’re doing what you’re doing, the whole subject of psychology goes away.

      A case in point is when Warren Buffett sold out of Fannie Mae (or was it Freddie Mac?), well before the disaster. How did he know? He knew, because he said that he often saw managements proclaimed that they were “going for growth” end in disaster. See? Buffett was able to avert disaster in his portfolio not by superior emotional ability per se, but by having a superior library of experiences from which to draw.

  5. Dear Mcturra:

    I guess you are talking about momentum (going with the news flow) and “value”/Contrary investing of going against news flow. Either way can work as long as you follow and understand exactly what you are doing. It is very difficult psychologically to do both–but it can be done. How did he do that? Go here for his blog (not posting since 2010) http://thefallibleinvestor.com/

    There are subtleties with Buffett’s comment. Yes, just going for growth without thinking of the investment required and resulting level of profitability is bad, but ESPECIALLY with leveraged financial firms. LEATHAL as 2008 illustrated. Revenue growth is caused by leverage and weak underwriting standards–note the history of banks, subprime lenders, and insurance companies, etc., etc.

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