Quantitative Value
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Table of Contents

Preface xi

Acknowledgments xiii

PART ONE The Foundation of Quantitative Value 1 CHAPTER 1 The Paradox of Dumb Money 3

Value Strategies Beat the Market 9

How Quantitative Investing Protects against Behavioral Errors 23

The Power of Quantitative Value Investing 30

Notes 32

CHAPTER 2 A Blueprint to a Better Quantitative Value Strategy 35

Greenblatt's Magic Formula 36

It's All Academic: Improving Quality and Price 45

Strategy Implementation: Investors Behaving Badly 54

Notes 59

PART TWO Margin of Safety-How to Avoid a Permanent Loss of Capital 61 CHAPTER 3 Hornswoggled! Eliminating Earnings Manipulators and Outright Frauds 63

Accruals and the Art of Earnings Manipulation 64

Predicting PROBMs 72

Notes 79

CHAPTER 4 Measuring the Risk of Financial Distress: How to Avoid the Sick Men of the Stock Market 81

A Brief History of Bankruptcy Prediction 83

Improving Bankruptcy Prediction 85

How We Calculate the Risk of Financial Distress 86

Scrubbing the Universe 89

Notes 91

PART THREE Quality-How to Find a Wonderful Business 93 CHAPTER 5 Franchises-The Archetype of High Quality 95

The Chairman's Secret Recipe 96

How to Find a Franchise 99

Notes 112

CHAPTER 6 Financial Strength: Foundations Built on Rock 113

The Piotroski Fundamentals Score (F_SCORE) 114

Our Financial Strength Score (FS_SCORE) 119

Comparing the Performance of Piotroski's F_SCORE and Our

FS_SCORE 122

Case Study: Lubrizol Corporation 123

Notes 126

PART FOUR The Secret to Finding Bargain Prices 127 CHAPTER 7 Price Ratios: A Horse Race 129

The Horses in the Race 130

Rules of the Race 133

The Race Call 134

A Price Ratio for All Seasons 141

The Offi cial Winner 142

Notes 143

CHAPTER 8 Alternative Price Measures-Normalized Earning Power and Composite Ratios 145

Normalized Earning Power 147

Compound Price Ratios: Is the Whole Greater than

the Sum of Its Parts? 150

Notes 163

PART FIVE Corroborative Signals 165 CHAPTER 9 Blue Horseshoe Loves Anacott Steel: Follow the Signals from the Smart Money 167

Stock Buybacks, Issuance, and Announcements 169

Insider Traders Beat the Market 173

Activism and Cloning 176

Short Money Is Smart Money 179

Notes 182

PART SIX Building and Testing the Model 185 CHAPTER 10 Bangladeshi Butter Production Predicts the S&P 500 Close 187

Sustainable Alpha: A Framework for Assessing Past Results 189

What's the Big Idea? 191

Rigorously Test the Big Idea 196

The Parameters of the Universe 206

Notes 208

CHAPTER 11 Problems with the Magic Formula 211

Glamour Is Always a Bad Bet 216

Improving the Structure of a Quantitative Value Strategy 218

Our Final Quantitative Value Checklist 222

Notes 228

CHAPTER 12 Quantitative Value Beats the Market 229

Risk and Return 231

Robustness 239

A Peek Inside the Black Box 249

Man versus Machine 257

Beating the Market with Quantitative Value 262

Notes 264

Appendix: Analysis Legend 265

About the Authors 267

About the Companion Website 269

Index 271

About the Author

WESLEY R. GRAY, PhD, is the founder and executive managing member of Empiritrage, LLC, an SEC-registered investment advisor; and Turnkey Analyst, LLC, a firm dedicated to educating and sharing quantitative investment techniques to the general public. He is also an assistant professor of finance at Drexel University's LeBow College of Business, where his research focus is on value investing and behavioral finance. Professor Gray teaches graduate-level investment management and a seminar on hedge fund strategies and operations. His professional and leadership experiences include over fourteen years building systematic trading systems, trading special situations, and service as a U.S. Marine Corps intelligence officer (Captain) in Iraq and various posts in Asia. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago Booth School of Business. He graduated magna cum laude with a BS in economics from the Wharton School, University of Pennsylvania.TOBIAS E. CARLISLE, LLB, is the founder and managing member of Eyquem Investment Management LLC, portfolio manager of the Eyquem Fund LP, and the author of the award-winning website greenbackd.com, which covers deep value, contrarian, and activist investment strategies. He has extensive experience in activist investment, company valuation, public company corporate governance, and mergers and acquisitions law. Prior to founding Eyquem, Carlisle was an analyst at an activist hedge fund, general counsel of a company listed on the Australian Stock Exchange, and a corporate advisory lawyer. As a lawyer specializing in mergers and acquisitions, he has advised on transactions across a variety of industries in the United States, the United Kingdom, China, Australia, Singapore, Bermuda, Papua New Guinea, New Zealand, and Guam, ranging in value from $50 million to $2.5 billion. He is a graduate of the University of Queensland in Australia with degrees in law and business (management).

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