As a developer and statistician, I consider value investing to be a statistically sound investment strategy. I've read a few books on the area but I am still not clear on valuation measures. So I would like to hear from experts in quantitative finance about the approach and its methods. For example, I would like know the pros and cons of value investing and what valuation methods are out there. Any opinions or references would be great, too. Thanks.
Value has traditionally been one of the most important stock-selection signals for quantitative managers. However, since the late 2000s, following a rapid flow into quantitative investing, traditional value strategies have lost most of their predictive power and the returns generated from them have also become more volatile.
The typical approach of quantitative managers is to distill a valuation measure into a "factor". This is often done using the hedged portfolio approach pioneered by Fama and French (1993). In this approach, analysts divide the investable universe into quantiles (typically in quintiles or deciles) to form quantile portfolios. Stocks are either equally weighted or cap weighted within each quantile. Each quantile portfolio’s performance is then tracked over time. A long/short hedged portfolio is typically formed by going long the best quantile and shorting the worst quantile.
A few of the most common valuation factors are:
Many of these also come in all sorts of simple or sophisticated variations. A few related factors that are not strictly valuation-based are:
These are just a few, and practically every paper published in the broad field of Behavioral Finance - Asset Pricing has been turned into a quantitative factor by someone somewhere.
Authors Ludwig Chincarini and Daehwan Kim, in their book, Quantitative Equity Portfolio Management, make a very interesting comparison of quantitative and fundamental investing:
J.P. Morgan's US Factor Reference Book provides a good (and very lengthy) overview of the state of the art. Lots of other major sell-side institutions also have their own stock selection models, such as Deutsche Bank, Macquarie, Bernstein, and Barclays. It is not always easy to access information on their products on the public internet.