Interview with authors of "Quantitative Value" Toby Carlisle & ; Wes Gray – Automating Low-Risk Value Strategies & Eliminating Behavioral Errors
“So the summary is that from a quantitative perspective Warren Buffett
was wrong and that his teacher, Ben Graham, was right.” This was Wes Gray’s
final interview comment with Miguel Barbosa. The interview was focused
on the findings and topics in the book, Quanitative Value authored by Wesley
Gray (Author/turnkeyanalyst.com) , Tobias Carlisle (Author/greenbackd.com).
Wes
Gray : “Cheapness is everything. That's the biggest takeaway anybody can take from
any of the research we (Wes Gray &
Toby Carlisle from their
book Quantitative Value) have performed. Quality matters at the margin, but
the minute you move out of cheap is the minute you shoot yourself in the foot.”
Interviewsfor investors is a new website run by Miguel Barbosa. Miguel commented "This website was
created to fill the "quality conversation" void perpetuated by
mainstream financial news sites,". Simoleon Sense is also one of
his many online contributions.
I strongly recommend reading the entire interview and the book Quantitative Value. Miguel has another interview that all serious investors would find outstanding, Interview with Value Investor Paul Lountzis – Applying Investigative Interviewing Techniques to Equity Analysis
There are multiple “takeaways”
from closely reading the article. I will present one of the core thoughts. These are the interview topics.
Part 1: The historical case for quantitative
value investing, models vs experts
Part 2: The quantitative
value model, the checklist approach to quantitative value investing, cheapness
is everything, obstacles, protecting capital, criticisms and misconceptions
Part 3: Applying the
quantitative model, rebalancing, holding cash & managing taxes,
international investing
Part 4: Closing Thoughts
Appendix: Toby & Wes on
Joel Greenblatt’s Magic Formula
Toby interview comments provide useful insight
into why models outperform the experts. Lots of research exists on experts
making errors. It applies to financial decision making but most of the published
research exists outside of finance. The illusion that extra information improves
forecasting is mistaken. It just increases confidence. Published studies have
verified this with doctors, horse handicappers and others areas.
Wes and Carlisle present a 3 step process
for quantitative value. The first step is to remove or try and remove tail risk
by excluding potential for permanent loss of capital.This would
remove according to Wes and Toby 10% of the firms in their sample. So if
they start with 1,000 they now have 900 firms. Second step would be to filter for cheapness
by decile. They select the cheapest decile. This would result in only 90 firms
left. The third and final step is to apply a quality measure on these 90 stocks. “Finally,
we buy the top half of the 90 cheapest firms.”
The interview covers thoughts on why they
ignore the Z score in favor of a PROB model/M Score. Simple version of
cheapness worked best. The surprising best measure was a single year EBIT/EV. They
tested permutations of different price ratios such as multi year averages of
many ratio like EV/EBITA,P/E,P/B,FCF/EV, and many others. The simple version
gave them the best performance. The final step is quality. But they found that “quality
type dimensions doesn't provide much of a boost.
At best you receive a tiny
marginal return on top of the return provided by the simple measures.”
Quality stocks were measured by examining two
factors, operational and financial strength. Hint they will use factors like,
modified Piotroski F Score, GP/total assets, and they speak in details on
other factors in the interview and the book.
Toby interview comments provide useful insight
into why models outperform the experts. Lots of research exists on experts
making errors. It applies to financial decision making but most of the published
research exists outside of finance. The illusion that extra information improves
forecasting is mistaken. It just increases confidence. Published studies have
verified this with doctors, horse handicappers and others areas.
Wes and Carlisle present a 3 step process
for quantitative value. The first step is to remove or try and remove tail risk
by excluding potential for permanent loss of capital.This would
remove according to Wes and Toby 10% of the firms in their sample. So if
they start with 1,000 they now have 900 firms. Second step would be to filter for cheapness
by decile. They select the cheapest decile. This would result in only 90 firms
left. The third and final step is to apply a quality measure on these 90 stocks. “Finally,
we buy the top half of the 90 cheapest firms.”
The interview covers thoughts on why they
ignore the Z score in favor of a PROB model/M Score. Simple version of
cheapness worked best. The surprising best measure was a single year EBIT/EV. They
tested permutations of different price ratios such as multi year averages of
many ratio like EV/EBITA,P/E,P/B,FCF/EV, and many others. The simple version
gave them the best performance. The final step is quality. But they found that “quality
type dimensions doesn't provide much of a boost.
At best you receive a tiny
marginal return on top of the return provided by the simple measures.”
Quality stocks were measured by examining two
factors, operational and financial strength. Hint they will use factors like,
modified Piotroski F Score, GP/total assets, and they speak in details on
other factors in the interview and the book.
