I thought I would take another look at models as the BBC are doing a series of features and programmes this week about robots and the possibilities offered by artificial intelligence, including this piece titled: Intelligent Machines: The jobs robots will steal first.
Regular readers will know that I have been developing and running an on going experiment with my own Scores Model which so far has been performing well. So with that in mind I thought I would revisit the case for using models in investing as it has been proven in many different fields that models or algorithms can often outperform experts and even when the experts have access to the models the models tend to act as a ceiling to prediction performance rather than a floor.
Don't take my word for it as there was a great white paper a while ago from Wesley Gray the Author of one of my favourite recent investing books Quantitative Value. On his site Alpha Architect as well as great research like this they also offer some free screening tools too. In this paper he looked at much of the background to the case for systemic decision making, giving examples of experts versus models in section 4.
However don't despair because before that in section 2 he did see a place for experts in the research, development and assessment of models, just not in the implementation as shown in this graphic below from the paper.
With that in mind I have been assessing my own Scores model as it has been implemented in a mechanical way and I do have a tweak to it that I plan to introduce at the next quarterly review at the end of this month - so watch out for that and if I get around to writing it up in more detail. If you are not interested in my model or don't want to develop your own then I would also recommend Stockopedia and their Stock ranking system, if you are not familiar with it, as the humans there have done a great job in developing a successful model for identifying stocks which are good value, quality and have momentum. It is a subscription based service but you can read more about it and get a two week free trial by clicking the link above if that is of interest to you.
Talking of models I note that there is also a ranking system for human models at a website called models.com where you can check out their rankings for models of the year 2014 and lots of other categories too if that is of any interest. Finally given the subject today I can't finish with out a bit of media to go with it. So on the visual front there was a good series recently on Channel 4 called Humans - which was about synths helping with domestic and other chores which was quite entertaining and worth catching up with if you missed it. While on the audio front this one seems appropriate. <END>
..as this is a post I probably should have done at the weekend but I was too busy playing cricket and enjoying the summer now it has finally arrived! Any way in much the same way that you might use left overs from the Sunday roast to make a meal on Monday, as it is also a quiet start to the week, I thought I would use this material to make a post today.
So this is one of those post where I share some of the stuff I have been reading recently that I found interesting and which I hope you might find useful and maybe even educational too. I say educational because it features comments form two professors.
First up in an interview with Robert Shiller which featured on the AAII website and is a look at bubbles, valuations and why interest rates / bond yields might remain low from here for a while yet.
Meanwhile the always useful Aswath Damodaran in his musings on markets blog looked at the Value and Pricing of Cash: Why low interest rates & large cash balances skew PE ratios. In this he not only does a teach in on calculating intrinsic value but also links to another post which looks at the combined effects of cash and debt on ratings. Interesting stuff and something worth thinking about when you are trying to assess fair values or come across a stock which seems to be on a cheap PE.
There you go and as I always try to educate and entertain so today you have had Stereophonic Professors as it were which puts me in mind of something which might entertain you and liven up a quiet day - so I bring you just enough education to perform, which has some appropriate titled tunes like - Mr. Writer, Every Day I think of Money and Have a nice day!
Football fans will be missing their Premier League fix this weekend ahead of England's latest thrilling (?) match against Switzerland next week. I have written about and put a checklist on my website as there have been academic studies showing that simple checklists can improve performance in complex situations like flying a plane safely, diagnosing diseases etc. There is also evidence that algorithms or simple mathematical models can often outperform individual and experienced practitioners, even when they have access to the models. Think Joel Greenblatt and what he saw when individuals used his system from the Little Book That Beats the Market.
So what does this have to do with the Premier League? Well with the closing of the transfer window last weekend and all the talk about the amount of money being spent, there was an interesting article on the BBC website looking at whether clubs had over paid or gained from their dealings in the transfer market. This referenced a database / model compiled by CIES Football Observatory, which tracks player and club performance and other things if that is of interest to you - apologies if you are not a football (or Soccer for an US readers) fan.
This also reminds of a good film I saw a few years ago called Moneyball which was based on a book by Michael Lewis about The Oakland Athletics baseball team and their general manager Billie Beane who used a quantitative, evidence-based, sabermetric approach to assembling a competitive baseball team, despite Oakland's disadvantaged financial situation. I know it sounds dull but I did find it quite entertaining and it even has a bit of eye candy for the Ladies as it has Brad Pitt in it plus Jonah Hill who put in a good performance as the statistics geek.
It is interesting that the owners of Liverpool FC also run the Boston Red Sox who tried to recruit Billie Bean, but in the end had to settle for using his techniques. Perhaps they are using similar techniques with Liverpool for their transfers as they seemed to have got Balotelli at a good price, also discussed in the article above?
...and other clichés of our time.
I thought I would tease you with this one and try and get you to read without prejudice. So here is an interesting looking chart with this stock up over 6 fold over the last five years, what can it be? Wow this must be a really exciting growth stock. So what about some history and financials.
Firstly the earnings have gone from 15 cents to 95 cents over the period so also up 6 fold or around 45% per annum.
Dividends have gone from 12 cents to 36 cents - so only trebled as cover has been built but still nearly 25% per annum.
Now this is where it gets interesting because they have achieved this on turnover that has gone up by only €1.2 billion from around €5.2 billion to nearly €6.5 billion or just 4.25% per annum huh?
On the financial metrics it has historically had operating margins of close to 10%, a ROCE of about 12% and a ROE 15%, so reasonable quality. It has revenues of over £5 billion and a market cap to match and an enterprise value of about £6.6 billion it's no minnow. In their recent results they reported operating profit up by 22%, earnings up by 37% and ROCE up to over 15%, while the dividend was raised by a useful 29%. Going forward it is forecast to see earnings up by around 10% this year and the dividend by 18% which leaves it on about 12x with a 3.4% yield 2.4 times covered. So reasonable value for such a great growth stock.
So what is it I hear you cry - well can you come back next week when I will open the box and see what's inside?
...but were too afraid to ask. Behavioural Finance (BF) is also known as behavioural economics. There are a couple of sites I have found dedicated to it, one is mentioned in the next paragraph and this one has a thorough book list relating to the subject. Of those featured on the list I have read books by Ariely, Belsky, Galbraith, Haugen, Kahneman, Malkiel, Montier, Shiller, Taleb & Thaler. I have therefore updated my reading list accordingly, certainly some interesting stuff on there worth checking out. There was also a good Horizon programme this weak featuring Daniel Kahneman the Nobel prize winning author of many good books on Behavioural Finance including the highly recommended Thinking Fast & Slow. You can watch the Horizon programme on the BBC I-Player here until the 5th March 2014.
To start there is an introduction to BF here but of more relevance to investors a short document about the Psychology of Successful Investing. It is a bit of a block of text so if you don't want to read it all then skip to the last page for the lessons to be drawn from it. Otherwise if you do read it you can note down the behavioural finance terms it refers to and look them up on the website it came from dedicated to BF. This also helped me to discover another Google service I didn't know existed called Google Scholar which you can use to search for research and other document on subjects you are interested in. Talking of which another research document - Which Investment Behaviours Really Matter for Individual Investors? by Joachim Weber et al. is even longer and more technical so extracts from this are as follows (my emphasis):
"The mean short-term investment skill in our sample is negative, which is in line with other
research on individual investors’ abilities (e.g., Meyer et al., 2012). It may therefore
be that better-diversified investors simply diversify away their lack of skill. As hard
as it is to always be right, it should also be hard to always be wrong. Less-diversified
investors then suffer more from the mistakes they make and realize lower returns than
their better-diversified counterparts without needing to be substantially less skilled."
"We investigate the multivariate relation between ten different measures of investment
behaviour and portfolio performance. Only for two of the ten measures scrutinized,
namely under-diversification and lottery-stock-preference, we find statistically significant
and economically large negative effects on performance. Reducing these behaviours by one
standard deviation relative to the sample mean would allow investors to improve their
annual returns by 3% for lottery-stock preference and 1% for under-diversification. Eliminating
these behaviours entirely would yield improvements of 4% for under-diversification
and 3% for lottery-stock preference."
See the full research document for full details. Finally see the latest CS Yearbook for 2014 which is just out and page 31 in particular for a piece on a behavioural take on Investor returns. It also has a topical piece on how Emerging markets have compared with developed markets in the long term. They also revisit their previous finding that historic high growth economies have given poor investment returns going forward.