There are many ways to make (and lose) money in markets, with no successful method being superior to any other. Certain methodologies and philosophies, however, are certainly more pervasive and, at least from my point of view, altogether more convincing. The two investment frameworks that capture my imagination most of all are what I call the stats and the stories – the Magic Formulas and StockRanks versus the Buffetts and the Mungers. Even though they are based on similar fundamental principles, the two schools of thought offer very different insights and, as someone sat on the fence between the two, I find myself asking the question, are the two methods compatible?
Introduction
First of all, a little introduction to the fundamental theory that underlies both of these investing methods. At the heart of both systems lies the concept of intrinsic value – the notion that businesses and assets have a certain, objective worth. Of course, I use the term objective loosely here; as anyone who has tried to value a stock before will tell you, the process is anything but objective. Nevertheless, while we may disagree on nuances, I think that when we consider the value of a business or productive asset to be the present value of its future cash flows, the statement stands and there is a definite figure or range of figures that we can identify as intrinsic value.
Following on from this is the idea that value and price are not synonymous. Something may have a certain value, but due to the wiles and whims of human nature it is often possible to acquire it for more or less than its true worth. From these two statements it is then relatively simple to derive our basic investment thesis – we try to buy something for less than it is worth so that we may sell it for a profit. This is the essence of value investing and as Charlie Munger famously says, “All intelligent investing is value investing – acquiring more than you are paying for.”
Stats
What I refer to as the statistical method of applying this idea is the concept that many quantitative fund managers and investment strategies such as the StockRanks make use of. Broadly, the thinking is that while we may be unable to accurately calculate the intrinsic value of a given company on a consistent basis, there are certain characteristics that undervalued companies,…
