Quantitative Value

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 Official 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