Equity Management: Quantitative Analysis for Stock Selection

Customer Reviews

Chapter 2 focuses on the use of regression analysis to "disentangle" various stock market anomalies. The authors claim that simple rules such as "Buy low-P/E stocks" are appealing, but oversimplify the true source of stock returns. For example, low P/E stocks tend to have higher rates of return, as do small-capitalization stocks. But if a small capitalization stocks also tend to have low P/E's, then how much of their return is due to the low-P/E effect by itself, and how much is due to the small-capitalization effect by itself? Jacobs & Levy have done the analyses, and show which effects are genuine, and which effects are merely proxies for other effects. The effects that turn out to be the strongest when "disentangled" include low P/E, Earnings trend, Earnings Surprise, Residual Reversal, and Relative Strength.

The introductory chapters in the book make some interesting points. They argue that the stock market is not random, but then again it is also not simple. Although simple rules are appealing to humans, they oversimplify the complexity of the market. To gain an edge, one must use sophisticated, objective, multi-factor statistical computer models that capture the complex interactions in the market. Of course the authors are saying this to advocate the techniques they use, but nevertheless, they have some good points.

Finally, the second half of the book focuses on the construction of long-short portfolios, though there is not much fresh material here. They point out some of the logistical details of running a long-short portfolio, and give some examples. Also, they introduce the concept of "alpha-transport." That is, one can construct a long-short market neutral portfolio, then by buying buy an index (using SP500 futures, for example) one "transports" the gains from the long-short portfolio onto the gains/losses of the index position. Thus, if the stock picking for the long-short portfolio is done correctly, the total portfolio will beat the index picked. To me, this seemed like an obvious technique; I'm surprised they decided to focus on it and give it a fancy name ("alpha transport")

Overall, I found the book interesting, though somewhat repetitious. I was familiar with much of what was covered, however I did find that Chapter 2 was worth reading, since I wasn't familiar with Jacobs & Levy's work in detail.

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