Stingy Investor Contact - Subscribe - Login
  Home | Articles | Screens | Links | SNW | Rothery Report
 
Smart investors use the numbers to make money

A huge pile of research points to an array of simple numerical stock strategies that boosts returns over the long term. Such methods range from low-ratio value strategies to momentum-oriented schemes.

If the studies are to be believed, it should be easy as pie to make a small fortune on Bay Street. (Even when you don't start with a large one.) All you have to do is to select a strategy and stick with it, letting the cold, hard numbers determine your buying and selling for you.

Picking a good long-term approach is one thing. But actually following it for a long period is quite another. It turns out that there are more than a few devils in the practical details.

I was recently reminded of a big one when I watched Tobias Carlisle's informative presentation to the UC Davis MBA Value Investing Class on quantitative techniques. He discussed James Montier's suggestion that numerical methods might represent a ceiling to potential returns, rather than a floor, for those who tinker with them.

Mr. Montier looked at how well a wide variety of simple models in many non-financial fields, ranging from medicine to criminal recidivism, worked. In nearly every instance, the models outperformed the experts.

For instance, he pointed to research by Leli and Filskov on diagnosing brain damage. For this purpose a model was developed that correctly identified 83 per cent of new cases, whereas professionals working from the same data got it right only 63 per cent of the time.

Thankfully, when you arm the pros with the model their performance improved. But here comes the kicker: They still only managed to get it right 75 per cent of the time. Yup, despite knowing the model's results, they failed to match it, let alone beat it.

Such findings are widespread in many fields. A meta analysis by Grove et al showed that simple models beat the experts in 64 of 136 studies, while another 64 cases basically resulted in a tie. A mere eight clearly went to the humans, and in those cases there were indications that the experts had access to more information than was provided to the models.

Based on such wide-ranging observations, Mr. Montier suggested that finance likely suffered from similar problems. In other words, investors might get the best performance from following simple stock screens to the letter, rather than using them as a short list to pick and choose from. The extra intelligence brought to bear on the problem might actually hurt returns.

Given my propensity to use screens, such considerations have been much on my mind for several years. It's also why I tend to equally weight portfolios (by dollar value) when screening, and generally opt for all the stocks a screen uncovers, rather than picking and choosing.

Mind you, the temptation to be more selective is quite strong and there are more than a few institutional pressures that can push people, such as your humble scribe, down such a path. After all, when someone asks you for your favourite stock, he or she generally doesn't want to be given a list of 20.

As it happens, money manager Joel Greenblatt ran an unintended experiment that suggests that stock investors suffer from the problems Mr. Montier warned about.

Mr. Greenblatt is the author of The Little Book that Beats the Market, and he espouses a mechanical technique called magic formula investing. His method screens for stocks with high earnings yields and high returns on capital. It buys, say 20 or 30 such firms and holds them for a year. (In practice, purchases are spread out over the year.) Although there is a little math and accounting involved, it isn't a very complicated approach.

Mr. Greenblatt manages money based on the method and offers investors two types of accounts. In one type, investors follow the method automatically. In the other, they start with his list and then pick individual stocks they want to buy.

Before jumping to the results you should be aware that the accounts have only been up and running for a few years, which is too short a period to yield a definitive answer. Nonetheless, so far things don't look good for the humans.

From May 1, 2009, to March 31, 2012, the strictly mechanical accounts achieved total gains of 84 per cent (after expenses) versus 63 per cent for the S&P 500. That's not bad. But the average returns for the accounts that were more selective - those investors who bought some of the magic formula stocks but not all of them - only gained 59 per cent. The extra effort was rewarded with substantial underperformance.

Such tentative evidence bolsters James Montier's case. Simple numerical strategies may well represent a ceiling to returns for most investors. It's something that's well worth considering the next time you screen for stocks.

First published in the Globe and Mail, December 9 2012.

  MoneySense Articles
 Cdn Top 200 2016
 US Top 500 2016
 Retirement 100: 2015
 Cdn Top 200 2015
 US Top 500 2015
 Retirement 100: 2014
 Cdn Top 200 2014
 US Top 500 2014
 Retirement 100: 2013
 Cdn Top 200 2013
 US Top 500 2013
 Retirement 100: 2012
 Buffett Buys
 FB IPO
 Stocks that pay
 Value in the S&P500
 Cdn Top 200 2012
 US Top 500 2012
 Retirement 100: 2011
 Where to invest $100k
 Where to invest $10k
 Summer Simple Way
 A crystal ball for stocks?
 Cheap & safe
 Risky business
 Cdn Top 200 2011
 US Top 500 2011
 Retirement 100
 Dividend investing
 Value investing
 Momentum investing
 Low P/E P/B
 Dividends
 Dividend growers
 Cdn Top 200 2010
 US Top 500 2010
 Graham's prescription
 Income 100: 2009
 The case for optimism
 Cdn Top 200 2009
 U.S. Top 500 2009
 Wicked investments
 Simply spectacular
 Income 2008
 Small stocks, big profits
 Cdn Top 200 2008
 US Top 500 2008
 Value that sizzles
 So simple it works
 Income 100
 No assembly required
 Investing by the book
 Cdn Top 200 2007
 US Top 500 2007
 Invest like the masters
 A simple way to get rich
 Top Trusts 2006
 Stocks for cannibals
 Car bites dogs
 Cdn Top 200 2006
 US Top 1000 2006
 So easy, so profitable
 Top Trusts 2005
 Dogs of the Dow
 Top 200 2005
 Money for nothing
 Yield of dreams
 Return of the master

MoneySaver Articles
 2 Graham Stocks for 2017
 3 Stingy Stocks for 2016
 5 Graham Stocks for 2016
 3 Stingy Stocks for 2015
 3 Graham Stocks for 2015
 3 Stingy Stocks for 2014
 4 Graham Stocks for 2014
 8 Stingy Stocks for 2013
 6 Graham Stocks for 2013
 9 Stingy Stocks for 2012
 8 Graham Stocks for 2012
 Simple Way 2011
 5 Stingy Stocks for 2011
 7 Graham Stocks for 2011
 Simple Way 2010
 5 Stingy Stocks for 2010
 8 Graham Stocks for 2010
 Simple Way 2009
 Timing Temptation
 19 Stingy Stocks for 2009
 4 Graham Stocks for 2009
 Simple Way 2008
 Active at Passive Prices
 Unbundling ETFs 2008
 5 Stingy Stocks for 2008
 5 Graham Stocks for 2008
 Is your index too active?
 Graham's Simple Way
 Canadian Graham Stocks
 5 Stingy Stocks for 2007
 8 Graham Stocks for 2007
 Top SPPs
 The Simple Way
 A hole in your IPO?
 Monkey Business
 8 Stingy Stocks for 2006
 Graham Stock Gainers
 Blue-Chip Blues
 Are Dividends Safe?
 SPPs for 2005
 Graham's Simplest Way
 Selling Graham Stocks
 RRSP Money Market Funds
 Stingy Stocks for 2005
 High Performance Graham
 Intelligent Indexing
 Unbundling Canadian ETFs
 A history of yield
 A Dynamic Duo
 Canadian Graham Stock
 Dividends at Risk
 Thrifty Value Stocks
 Stocks in Short Supply
 The New Dividend
 Hunting Goodwill
 SPPs for 2003
 RRSP: don't panic
 Desirable Dividends
 Stingy Selections 2003
 10 Graham Picks
 Growth Eh?
 Timing Disaster
 Dangerous Diversification
 The Coffee Can Portfolio
 Down with the dogs
 Stingy Selections
 Frugal Funds
 Graham Revisited
 Just Spend It
 Ticker Temptation
 Stock Mortality
 Focus on Fees
 SPPs for the Long Term
 Seeking Solid Stocks
 Relative Strength
 The VR Approach
 The Irrational Investor
 Value Investing

Globe & Mail Articles
 Indexing advice
 Media-shy stocks
 Curse of size
 Market uncertainty
 Be even lazier
 Scary beats safe
 Small, illiquid, value
 Use the numbers
 What value is good value?
 Sculpt for value
 Value vs CAPE
 Graham Rules
 CAPE vs PeakE
 Top value ratio
 Low Beta
 Value and dividends
 Walter Schloss
 Try unloved AIG
 Why I'm a value investor
 New world of ETFs
 Low P/Es possible
 10 yielders
 Be happier
 Long-Short
 Dividend Downside
 Shiller's P/E
 Copycat investing
 Cashing in on class
 Index roulette
 Theory collides
 Diving too deep
 3 retirement villains
 Scourge of inflation
 Economic omens
 Analyst Expectations
 Value stock scarcity
 It's all in the index
 How to pick good funds
 Low Beta Wins
 Hunt for dividend stocks
 Think garage sale

Advisor's Edge Articles
 Passive Rebundling
 Doing the math

Norm Speaks
Flip Books

Tools:
 Asset Mixer
 Periodic Table
 ETF Fee Calculator



 
About Us | Legal | Contact Us
Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...