Last Updated September 19, 2011
I recently read “Painting by Numbers – An Ode to Quan” by James Montier and Dresner Klienwort via a link from Richard Beddard to Greenbackd. This paper, and the papers it refers to, have helped strengthen some of my existing opinions about stock picking and investing in general.
My opinions are also those of Ben Graham towards the end of his life, that “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham and Dodd” was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost” (www.bylo.org/bgraham76.html).
Painting by Numbers backs the argument that human judgement typically offers no benefit to decision making where that decision can be made instead using simple quantatative methods. Many examples are given of decisions made by doctors, judges, parole boards, purchase managers, wine experts, and in almost all cases the application of simple statistics produced better (or at least as good) outcomes. A breif example which comes to mind is of a parole board deciding whether to let a prisoner out early. Is the best decision (on average) made by the experts on the board, or by calculating the odds that the prisoner will re-offend based on data like sex, age, background, criminal record, offences commited inside prison, etc. With hindsight the quantatative approach produces the better answer most of the time. Although I’m sure there are many studies to counter this argument.
This tied in somewhat loosely with a TV program on the other night called The Secret Life of Chaos. In the ‘secret life’ one of the scientists commented on how all the glorious patterns and structure in the universe can emerge from a relatively simple set of rules; or at least simple in relation to the patterns and structures they can generate. He said, more or less, that if there was a job for God it it was to set the initial conditions for the system and then let it do its thing. No further tweaking or interference is either desirable or required.
From a statistical investing point of view, this means it is probably better to play the odds. By finding out the quantatative features of those companies that have, in the past, done best over the following 1-5 years (or whatever your investing timeline is), it may be possible to have an opinion on which companies are more likely to do better in the next 1-5 years.
Research gathered by Tweedy Browne in What Has Worked In Investing among many others, shows that this is possible (or at least, probably possible). The lesson for me is: build a mechanical investing system; set it in motion; and as much as is humanly possible, leave it alone.