Quantitative Value, + Web Site: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors

PART SIX

Building and Testing the Model

In this final part, we discuss how we construct and test our quantitative value investment model from the research we've examined in the book. In this chapter, we discuss our philosophy for conducting investment simulations, and survey the potential pitfalls in interpreting back-test results. We cast a suspicious eye on back-tested, and real, historical results, closely scrutinizing the steps we can take to ensure that results are genuine, and replicable.

In Chapter 11, we study the best way to combine the research we've already considered into a cohesive strategy. We examine the Magic Formula and the F_SCORE to see if we can find a better structure for our valuation model. Our process leads us to identify some potential structural issues with the Magic Formula.

In Chapter 12, the final chapter, we back-test the quantitative value model we created in Chapter 11. We take a comprehensive look at its raw results and its risk- and opportunity-cost-adjusted performance. We compare it to the Magic Formula's performance and the performance of other legendary investors. We also open up the black box, inspecting in granular detail the stocks bought by the strategy over the course of the back-test period.