Can anyone be a Warren Buffet? (book review)

If there is one thing that I’ve learned from reading about different investing strategies over the past few years, it’s this: active equity investing is very difficult, and you need to be very sure of yourself to think that you have better knowledge about the price of a security than whatever “Mr. Market” decides it is.

Quantitative investors tend to rely on algorithms to automate trading, while value investors seem to pride themselves on their ability to be successful by doing intense research and by having the courage to make judgments on highly subjective decisions. And never the twain shall meet, right?

Perhaps not. One of the more interesting books that I’ve read lately is “Quantitative Value,” by Wesley Gray and Tobias Carlisle. In it, the authors argue that the best way to do value investing is by taking a quantitative approach, and that automating the investment process by screening for value factors can result in superior returns.

Essentially, they want to figure out how to automate the best of Buffet style value investing to make it accessible to more people.

The book starts out by observing the favorable results that can be had by investing with Greenblatt’s “Magic Formula,” which is a simple quant screen that searches for stocks based on earnings yield and return on capital. The authors argue that the success of this approach is due largely to the fact that it allows individuals to capture the well documented Value Premium that comes from owning under-priced stocks, and also prevents investors from making dumb errors in implementing their strategy. There are reams of literature on the behavioral biases that plague investors, and applying a simple and consistent quant screen can allow investors to capture the well-documented value premium in a systematic way.

However, the book goes several steps further by showing investors how they can use academic research to improve the results of this sort of quantitative screen. The book’s chapters each build on a different area of research, including bankruptcy prediction, the Piotroski F-Score (which screens for financially strong companies), and discusses how to implement the findings of those results into your investment process.

Overall, I really enjoyed Quantitative Value. It made me think about the limits of my own knowledge, and opened me up to thinking about how Buffet style investing can be implemented in a rigorous and systematic way. I think that it can be best used and tested if you have an aptitude for statistical programming and access to large databases such as Compustat, but from what I can tell, sources such as Bloomberg and various other online quant screens should have enough information to implement a version of this program.

Has anyone out there tried to implement the ideas from this book? What do WSO’s buyside and trader posters have to say?

A pretty good white paper is here.