The first version of What Works on Wall Street, by James O’Shaughnessy, was received very favourably by the investment community. Stock Traders Almanac called it the “best investment book of 1996” and “likely the most influential book on investing in the decade”. It was praised for it’s attention to detail and in-depth research into the factors that affect stock performance.
Since then, there have been four different editions of the book and the latest (published in 2011) is a must read for anyone interested in quantitative investing.
What Works on Wall Street Review
What sets this book apart is the depth of research that O’Shaughnessy undertakes in order to uncover investing truths. While most books only talk about the last 5 or 10 years, Shaughnessy is able to obtain data going back 90 years in order to test which investment strategies work, which fail, and which fundamental factors are the most crucial for success.
It is incredibly difficult to get hold of such data so O’Shaughnessy does readers a great favour by obtaining the data and running his own rigorous analysis on it.
By doing so, O’Shaugnessy is able to go back as far as 1926 in order to answer such important questions to investors as:
• What factors most reliably indicate stock price growth or decline?
• Do small cap stocks outperform larger stocks?
• Which strategy is better, value or growth?
• What is the worst-case scenario to expect from various investment methods?
After introducing his methods and rules, and the data which he will be using, O’Shaughnessy systematically goes through each investment strategy and fundamental factor, chapter-by-chapter, one by one, debunking many myths and reporting on many interesting insights along the way.
He looks into price-to-earnings, price-to-cash, EBITDA, price-to-sales, price-to-book, dividend yield, shareholder yield, accounting ratios, and various other metrics to see which metrics have been the most important over the last 90 years.
His findings are interesting. There is no magic ratio that is going to assure market-beating returns, though screens that combine value based metrics do seem to outperform other strategies such as growth investing.
O’Shaungnessy tests each ratio individually which is important, because it allows the reader to separate each one out and see it’s importance on a broader scale.
However, it seems that the most success comes from combining ratios. Something I found for myself when developing my own value investing rules, where a combination of different fundamental metrics leads to outperformance both in terms of annualised return and drawdown levels (risk).
It’s unwise to look for a holy grail when reading O’Shaugnessy’s work, but if you want it, one answer would be to go for small cap stocks that trade with low valuation ratios based on earnings, sales, cash, and book value.
These are the types of stocks that have done the best over the last years, consistently outperforming other metrics and methods of investment. But to derive just this from a book of such value would be a disservice, since the book has many more important lessons to be learnt.
All in all, this is another excellent book from James O’Shaugnessy. It is a book without fluff. One that gets right to the heart of financial analysis and quantitative, passive investing. For anyone who likes that kind of thing, it’s a must read.