The Dangers of Quantitative Value Investing
In recent years, quantitative stock analysis has taken the investment world by storm while qualitative analysis has been given a back seat. Value investing however — as Benjamin Graham would remind us — is both an art and a science. A new study in the CFA’s Financial Journal showed the underperformance / diminishing alpha of stocks chosen purely based on their quantitative value, and explains why value factors taken alone aren’t great indicators. But first, a quick trip into the value investing time machine.
Quantitative Value Investing History
Benjamin Graham’s and David Dodd’s 1934 Security Analysis is the seminal book on value investing. Security Analysis offers investors a comprehensive guide to analyzing companies to find value stocks which are priced below their intrinsic value. Graham & Dodd advise a number of strategies to find value stocks, ranging from qualitative factors like identifying industry trends and a company’s management team to quantitative factors like book value, P/E ratio, and sales-to-price. As Graham’s value investing ideas gained popularity in the investing community with disciples like Warren Buffet and Mario Gabelli, a ton of portfolio managers and private investors began mining his work to develop their own investment strategies.
With the advent of powerful computers, databases, and stock screeners it has become increasingly easy for investors to implement Graham’s quantitative strategies, while the qualitative study of companies remains nearly as time consuming and research intensive as it was in 1934. This imbalance of effort has generated a dangerous proliferation of quantitative investing without qualitatively studying stock fundamentals.
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