Customer Reviews

What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of all Time

5 star:		(34)
4 star:		(20)
3 star:		(15)
2 star:		(7)
1 star:		(8)

 

 

What Works on Wall Street? According to a study of 45 years of stock market data in a book called "What works on Wall Street" by O'Shaughnesy he came to the conclusion that some strategies would have produced greater returns than the S&P 500 whilst others produced less. He tested a range of strategies, re-balancing the strategies annually, with each strategy involving the 50 stocks which met the criteria for inclusion.

The worst strategy that you could have adopted was to buy last year's losers each year. The message is clear - losers carried on being losers. Sometimes the weak beats the strong, but it's not the way to bet your money.

The next ten worst strategies involved buying Companies on high multiples such as high price to sales ratio companies. These companies were generally on high multiples because they were thought to be high growth or sexy companies with lots of potential. They were the then current stock market darlings that investors were prepared to pay up for in order to join in with the latest investment fad or fashion.

As far as the best performing strategies are concerned, he found that the top 6 strategies all involved buying companies with high relative strength in combination with a value factor such as low p/e or low price to sales ratio. These companies were generally on low multiples because they were in out of favour sectors or old economy share that had been overlooked. By combining it with high relative strength (i.e. shares which were rising), these strategies caught those shares whose under-valuation was finally starting to be recognised by the market.

The book found that over long periods, adopting the following rules would have proved to be more profitable than buying the S&P 500: Low price to sales stocks out-perform the higher p/s stocks. Low price to cash flow stocks do better than high p/cfl stocks. Low price to book stocks tend to perform better than high p/b stocks. Other conclusions reached in the book are as follows: Price to sales ratio is the best single value ratio to use for buying market beating stocks. Last years biggest losers are the worst stocks you can buy. Last years earnings gains alone are worthless when determining if a stock is a good investment. You can do four times as well as the S&P 500 by concentrating on large well known stocks with high dividend yields. Relative strength is the only growth variable that consistently beats the market.

Buying Wall Street's current darlings with the highest price to earnings ratios is one of the worst things you can do.

Other lines from the book: Growth investors believe in a Company's potential and think a stock's price will rise with its earnings.

Value investors believe in a company's balance sheet, thinking a stock's price will eventually rise to meet its intrinsic value.

The S&P 500 tracker strategy is a strategy making disciplined bets on large cap companies. This strategy is just one of hundreds of strategies which could exist. For example another strategy might be to measure the performance of all stocks that begin with the letters h,l,m,n, and p. There are many other strategies which have given higher returns in the past than the S&P 500 strategy, some for no logical reason, others with a certain logic. Examples of logical strategies include a disciplined small cap strategy, or a disciplined low price to sales strategy or a disciplined high yield strategy etc. Some of those strategies also performed more consistently than the S&P 500 strategy, ie with less risk.

For example if in the 1950s the editors at Dow Jones had decided to revamp the index buying the 50 stocks with the lowest price to sales ratio, then the Dow Jones Industrial Index would be at 4 times the level of today.

People want to believe the present is different from the past. The price of a stock is still determined by people. As long as people let fear, greed, hope and ignorance cloud their judgement they will continue to mis-price stocks and provide opportunities to those who rigorously use simple time tested strategies to pick stocks. Names change, industries change. Styles come in and out of fashion, but the underlying characteristics that identify a good or bad investment remain the same.

I work with Jim O'Shaughnessy and I would just like to clarify Mr. McMahan's comment on the data in the new edition. The newest edition of What Works on Wall Street does in fact contain updated data through the end of 2003. The prior editions were through 1994 and 1996, so in addition to new series, monthly analysis and several new chapters there are also seven more years of data.

As a biased observer (I would have omitted my star rating but Amazon won't allow me to post without it) I will refrain from commenting on the other statements appearing here, but should people be interested in judging for themselves please be careful that the edition purchased from Amazon is from May 2005.

James O'Shaughnnessy's book is the latest to engage the Age Old Question: growth stocks or value stocks? Instead of focusing on those 2 sectors specifically, he meticulously looks at the multi-decade history of various metrics -- price-sales, price-book, price-earnings, etc -- in making sound investment decisions.

The books major highlights are as follows:

(1) A bent towards small and microcap stocks, particularly value-oriented stocks, works very well. Buying microcaps is difficult for institutions but NOT for most individual investors.

(2) Price-sales is underused as a method for finding good (value) stocks and market-beating performance.

(3) Price-earnings and dividend yield are also good indicators, especially in the context of larger cap stocks.

(4) Value edges out growth. (NOTE: The starting and ending points for measuring long-term cycles are so important that changing the dates by a few years can often reverse the results. While value stock investing might have a slight edge in the time frames studied in "What Works On Wall Street", keep in mind that depending on where growth and value stocks are in their respective cycles when you decide to invest is very important to your portfolio choices. For instance, after a big value runup, growth stocks often outperform for a decade or so.)

(5) Using more than 1 metric is important in helping outperformance while reducing risk/volatility.

The book has tons of data and backs up its claims well. Keep in mind, this book was published in 1998 with the data going through 1996. Had the data stopped at 1999, the results would have looked VERY DIFFERENT! And, of course, had it been updated through recent years, different again.

All in all, a very worthwhile book, though you can get lost and immersed in so many numbers at various times that you forget "the big picture" which thankfully O'Shaugnnessey repeats often enough to make sure the reader comes away with the basics.

this book is packed with so much historical data that it can drivey you nuts! the only parts of the book that are interesting is when the author states the implications of certain data sets.

the main items of interest really are to invest in:

- low price/sales (psr) on large (>150m market cap) stocks
- low p/e on large stocks
- low price/book on large stocks
- low price/cashflow on large stocks
- focus on stocks w/ best 1 year relative price strength
- focus on stocks w/ <25m market cap

the rest can be tiring...

I am an engineer and geek at heart. This was the first investing book that I have read that gave me all the data that I could ever want to back up what was asserted in the conclusions. He gives clear directions on how to pick a 25 - 50 stock portfolio that over any rolling 5 year period will seriously out perform the market. I bought the first edition and had a paper portfolio for a few years before I made the plunge and invested real money. My 50 stock portfolio that has 25 stocks from the Cornerstone growth formula and 25 from Cornerstone value has averaged better than 26% annual returns over the last three years. I created the portfolios inside a self directed IRA, so I don't have the tax consequences for rebalancing every year. And, the returns mentioned about include spending $10 per trade in my Ameritrade account. If you're not into all the data, buy his book "How to Retire Rich". It's a recap of this book and is an easier read than "What Works on Wall Street." In "How to Retire Rich" he calls Cornerstone Value "Leaders with Luster" and Cornerstone Growth is "Reasonable Runaways." In the 3rd edition of "What Works on Wall Street" he tweaks the value screen to include a test for shareholder yield. If you get to the point of buying "How to Retire Rich" and using the strategies from that book, check out the 3rd edition of "What Works on Wall Street", Chapter 19, for an explanation of shareholder yield.

This book has put my retirement plans back on track and I'm confident that I will be able now to retire with enough money to live comfortably.

The author went through the Compustat database to study the effects of eleven financial ratios on a hypothetical portfolio that was rebalanced once a year. The financial ratios or parameters are: market cap, price to earning, price to book, price to cash flow, price to sales, dividend yield, 1 year earning's growth, 5 year earning's growth, profit margin, return on equity, and price momentum. The study spans over 45 years. For each parameter he reports the portfolio return by year, and the return's arithmatic mean, standard deviation, geometric mean, Sharpe ratio, and how often it beats (or conversely underperforms) the broad market.

He then studies performance of portfolios that combine high or low values of several of the above financial parameters. And he does present some very interesting and useful results here.

Arguably one must already have some familiarity with various stock picking strategies, and some comfort with statistical analysis, to profit from this book. The book has two main weaknesses: (1) The author gives no reason to believe that the past performance will indeed guide future performance, and (2) The author gives no information on the turnover encountered by each portfolio strategy. Hence unless your investment portfolio is limited to your retirement account, you don't know whether following the conclusions from this study will really make you additional AFTER TAX money, compared to a low turnover S&P500 indexing strategy.

Nevertheless the book presents ORIGINAL reliable and FACTUAL informaion regarding how the US market behaved between 1951 and 1996. That in itself makes it more useful than most investment books. If you happen to be serious about investing in stocks, you simply can't afford to ignore these results.

This is an extremely valuable book on investing not so much for its excellent analysis of screening methods but also for its implications about investment managers. Too often the investing public sees or hears investment gurus pick stocks for what appear to be valid reasons even though there is little or no research to justify the screening criteria. A Boston based investment firm that used to have a good reputation backed away from buying C when it was at $5 (split adjusted). They missed a six-fold increase in the stock price because their retail/entertainment analyst (not the courageous auto analyst) had convinced the portfolio managers that ROE was important. At the time, C had a negative ROE. This same analyst convinced the same portfolio managers that TWX was a great EBITDA stock. (Earnings Before Interest, Taxes, Depreciation and Amortization) was NEVER tested by the portfolio managers as a criteria for selecting stocks (NET income and Depreciation and Amortization was tested by O'Shaughnessy and found to be a reasonable screen). These professional investors bought one of the worst performing stocks in the S&P 500 over the last five+ years on the basis of absolutely NO research whatsoever on EBITDA. Many so-called professional investors use other flawed methods to screen for stocks and their explanations are often colorful, utterly convincing but grossly misleading. Mr. O'Shaughnessy's work, though it could be more rigorous in terms of some statistical tests such as the Bonferoni and non-parametric ratio analysis, at least points out that there may be some valid ways to attempt to beat the market. Anyone, such as Mr. O'Shaughnessy, who tries to validate his selection methodology by analysis deserves praise. The typical professional investor who validates his approach by emotional appeals or the mystique of professionalism deserves the underperformance that most of them have achieved. After reading this book and comparing the methods that most active portfolio managers use, it's very easy to understand how over 80% of them can't beat an index fund. They don't even know where to start.

This book should be read in conjunction with the author's other books. After reading his much simpler, "How to Retire Rich" some 5 years ago or more and with a "wealth" of relatively poor investment experience under my belt it was clear to me that Reasonable Runaways was the way to go. However, there were a number of uncertainties. The basic question the author was answering - how do I maximize a lump sum I have now over the long term i.e. 15, 20 years or more - was not exactly the same as the question I was trying to answer. My problem was - how can I invest regular monthly surplus sums from my salary and maximize the value over the long term. It took me a few months to figure out that I could do it. Instead of rebalancing the entire portfolio once a year I rebalance a 12th part of it every month. I am therefore "rebalancing" i.e. selling what I bought 12 months (plus a day) ago and purchasing the next few stocks that pop out of my Reasonable Runaway's screener that I don't already own. Of course the math is a little convoluted and I am never really going to get the rebalancing absolutely correct but I still end up with a pretty well diversified portfolio that I am regularly turning over on a steady and most importantly unemotional objective basis. When I analyze the performance on a trade by trade basis I find the inevitable reversion to the mean. After a total of 109 trades I have calculated an average annualized performance (for simplicity and tax reasons I extended the holding period to 13 months) of 21%. What is more this average performance is quite stable over the last year or two. I still have a spectacular variance in individual performance but the net result at the end of each year averages out in the healthy positive direction. The more I have been doing this since starting in May 2002 the more I am asking myself why there isn't a massive crowd of investors buying those buys just before me and selling them just before me driving my purchase prices up my selling prices down and my profits into the cellar. The answer is clearly to be found in the author's recent third book "Predicting the Markets of Tomorrow". It appears that there is only a very small crowd of us out there who can stomach the ups and the downs and ride out the course. I've tried to figure out whether the author knows that his strategies when spread out on a rolling basis - as I describe above - give the investor a much steadier and healthier performance and therefore much less emotionally challenging ride. I also suspect that my approach of buying the next stocks down the list on the screener every month means that I am often buying the stocks that most recently arrived on the list and possibly more likely therefore to perform better. But then I am still an amateur at this and decided not to break my head any further. Back to "What Works on Wall Street". There is a really exciting part (sad isn't it but seriously when you see how well this stuff works it is a lot of fun) when he explains how tweaking or combining the value strategies reduces volatility and improves overall return. When I read that I assumed he was going to expand further but the point sort of got lost and I'll have to do a re-read to find it again. As an amateur I am also stuck with internet stock screeners and not all of them give you the parameters or the level of detail you need to get the screener working exactly as you need. The best advice on that is given at the end of "Predicting the Markets of Tomorrow" fortunately for me I worked that out for myself years ago. If you are like me you will end up reading just the main text and skimming over the tables. Do I recommend this book? Well put it like this - I am pretty certain that I will be retiring rich thanks to Mr. O'Shaughnessy (Seriously Sir if you do ever read this, my sincere gratitude.) I am just surprised to discover that there seem to be so few of us out there able to pick up on this and follow through.

This book has born out its wisdom. The two funds that are patented that fool his strategy have been phenomenal. HFCGX is the patented fund based on his top idea of Cornerstone Growth; over the last 5 years it has had an average return of 13.44% per year vs. the Vanguard 500's -2.01% per year (6/1/00 through 5/31/05). HFCVX is the patented fund based on his 2nd to best idea of Cornerstone Value; over the last 5 years it has had an average return of 6.47% per year vs. the Vanguard 500's -2.01% per year (6/1/00 through 5/31/05). The most interesting point is that the author points out that investors often are to emotionally involved to have the discipline to see the strategy through. Not only did the first reviewer bash the book because he did like the returns strategy one year after the book came out, but Mr. O'Shaughnessy sold the funds to Hennessy Funds at the end of 1999 after it failed to surpass the returns of the bubble that soon after collapsed. Seven years after it was published an investor would be much wealthier had they followed the books top strategy instead of the investors who dogpiled onto the stocks of the market's bubble. THIS BOOK is my all time #1 resource for stock investing. Five Stars.

This is clearly one of the ten most significant financial books of the last twenty years. Irrespective of the reviews here, there are a lot of big names on Wall Street and in academia who will agree with that statement. Although Jim won't win a Nobel prize for it, his number crunching tour-de-force has significantly added to the work of the U of C crowd and many others. There ARE characteristics that the market rewards over time, though even Nobel laureates can't explain exactly why. If you don't like indexing, think NASDAQ 4000 makes sense, believe the performance of the author's mutual funds over 1-2 years are predictive of their long term performance, and are looking for a book full of amusing anecdotes justifying the author's pet theories, then this book is likely not for you. (Though to be fair to Jim, I've been pretty happy with the recent market-beating performances of his OSAGX and OSCGX funds. But, as Jim preaches, short term returns are irrelevant, so I'll try not to gloat!) However, if you have what it takes to be a true long term investor, this book may be one of the most profound you ever read.