Warren Buffett was wrong, Cheapness is everything

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.


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