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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).