Recommended Investment Book
Paul Dietrich of Foxhall Capital Management Inc. recently recommended to me a book, ‘Quantitative Strategies for Achieving Alpha’ by Richard Tortoriello. Paul was aware of my admiration of James O’Shaughnessy’s excellent book, ‘What Works on Wall Street’ which is a similar book.
As a key analyst for Standard & Poors, Tortoriello had access to the excellent S&P extensive database which enabled him to research over a long period the effectiveness of selected investment criteria. This wonderful book is out of print and very hard to get hold of – I had to pay just over £100 for a copy (secondhand copies can be found online at Amazon and other retailers). It is however, available on Amazon’s Kindle for £38.10. For any serious investor the book is a must. It is 460 pages long so I will try to give you a quick insight into some of the points that interested me particularly:-
- Like O’Shaughnessy, the author found that relative strength was a very powerful single price driver. O’Shaughnessy usually works on relative strength in the previous year and so do I. However, Tortoriello found that relative strength in the previous seven months gave the best returns.
- Earnings growth is the primary driver of stockmarket returns. Sales growth is a secondary factor.
- Earnings growth is not predictive of future returns because the market is very efficient at pricing in changes in the rate of earnings growth.
- Free cash flow (ie: cash flow after capex) is another significant factor in driving share prices upwards but not as strong as earnings growth. Interestingly free cash flow is predictive.
- A low forward price earnings ratio works well quantatively.
- Return of Equity is a simple profitability strategy that works well.
- There are a number of red flags that are warning signals. For example, companies with high annual capital expenditure do not usually perform well.
- Positive momentum works very well in tandem with low valuations. For example, good relative strength and strong free cash flow produce excellent returns.
As you know, for growth stocks, I recommend using a low PEG (ie: strong EPS growth coupled with a low forward multiple), strong cahs flow in excess of EPS, above average relative strength in the previous year and no substantial directors selling. As a result of reading Tortoriello’s book, I am going to pay more attention in future to relative strength in the previous six months (available in Company REFS) and calculate and use free cash flow (easily done with Company REFS) as another key criterion.
You may find it more user-friendly when reading this book to understand first Tortoriello’s method of research by reading the first few chapters very carefully. After that skip the very detailed research and read the extensive and excellent summaries of his conclusions in subsequent chapters.
This book is a must for serious investors.