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
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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