We Study Billionaires - The Investor’s Podcast Network - TIP 057 : What Works On Wall Street with James O'Shaughnessy (Business Podcast)

Starting point is 00:00:00 We study billionaires, and this is episode 57 of The Investors Podcast. Broadcasting from Bel Air, Maryland. This is the Investors Podcast. They'll read the books and summarize the lessons. They'll test the waters and tell you when it's cold. They'll give you actionable investing strategies. Your host, Preston Pish, and Sting Broderson. Hey, how's everybody doing out there?

Starting point is 00:00:30 This is Preston Pish, and I'm your host for The Investors. podcast and as usual I'm accompanied by my co-host Stig Broderson out in Denmark. And I'll tell you, folks, this one here is a really exciting episode for Stig and I because we have one of the most influential investors we've ever interviewed on our show, and that is Jim O'Shennessy. And Jim really has quite a background. He's the chairman, CEO, and CEO and senior portfolio manager for O'Sheny Asset Management. And now if you're saying to yourself, Jim, his name sounds familiar. I've heard his last name before. It's all because of the fact that he wrote this book called What Works on Wall Street.

Starting point is 00:01:09 And it's one of the best-selling investment books that you'll find on Amazon. I know Stig and I both own copies of this. We also have Toby Carlisle with us, who's the author of Deep Value and Quantitative Value, because Toby is a huge fan of Jim's along with Stig and I, and we felt like Toby would be one of the great people to bring on the show to help us ask questions for Jim. If you don't know who Jim is, he has been recognized as one of America's leading financial experts and a pioneer in the quantitative stock analysis realm. And he has been called one of the world beaters and statistical gurus by Barron's. In February of 2009, Forbes.com included Jim in a series on legendary investors along with Benjamin Graham, Warren, Buffett, Peter Lynch.

Starting point is 00:01:56 And to say that he's one of the best in the field is totally an understatement. So, Jim, we are so thrilled to have you on the show. And thank you so much for taking time out of your busy schedule to talk to Stig, myself, and Toby. We just really appreciate it. I'm delighted to be here. Thanks for having me. So we want to start off the episode by handing this over to Toby because Toby has become a really well-known author in value investing and just one of the people leading in the investment community with this idea of quantitative value. but Toby has something that he wants to tell you before we start off this episode.

Starting point is 00:02:34 I think to give Jim, his due, might have founded the entire field of quantitative investing. I started out like a lot of guys reading the Graham books, security analysis and an intelligent investor. And I think as you go along trying to apply some of those rules, you realize how hard value investing really is. There's a great point that I saw on Twitter the other day from Dave Collum where he said something like, investing is really easy, just calculate intrinsic value and then buy it a price that's a discount to that. And then somebody said, how do you calculate intrinsic value? And he said, that's really hard. And that's the case, I think, for most people, when you start investing, you discover it is really, really difficult. And that process for me led me into, in a quantitative direction,

Starting point is 00:03:16 which is where I discovered James Montere had this great paper. I think he wrote it in 2006 called an ode to quant. And I read through that and I thought, this is kind of scientific application of Graham's principles. And it was at that stage that I discovered what works on Wall Street. And I realized that I think that it was 10 years old at that stage, Jim. Is that right? Yeah. Did you discover the fourth edition or an earlier one? No, I found one of the editions online and had to look through that. And then I went and bought a few desk copies and I have bought them ever since. I appreciate it. And basically what the book is, an encyclopedia of all of the ways that any

Starting point is 00:03:56 the fundamental metrics or price action metrics that you can apply to the market and work out how to beat the market because it turns out that if you examine many of these quite predictive metrics, the glamour in evaluation sense tends to underperform the market, the value tends to perform. So the question that I have, Jim, after that long lead in, is I think that the quantitative application of those rules sort of requires some humility to say that perhaps your own mind isn't the best way to do these things. I was just wondering what was it in your background or your personality that sort of led you in that direction rather than keeping it all to yourself and just representing yourself as a super investor. Well, thank you. I have a really large need to share. I think

Starting point is 00:04:40 that most investors go about investing in exactly the wrong method. And I felt that if I could publish a book showing factually what were the best metrics to look at, that I, I would be able to help large majority of investors. And I also knew that human nature being what it is, that they might get very excited about it, but the moment it stopped working, they would abandon it. I mean, I've seen this time and time again. I've had investors who have been with me for years, getting great performance, and then suddenly we have a bad year or a bad couple of years, which we've told them about

Starting point is 00:05:23 ahead of time, right? Because we can always show them that nothing works all the time. So I didn't have any fear of releasing all of this data simply because I knew that human nature was such that the moment it wasn't working, they would abandon it. And that's exactly what we've seen. We see that, for example, people are judged on the wrong time periods. I'll give you a good example. So there was one five-year period in our study where sales growth just swamped the S&P 500. I mean, it was amazing. And it's a good story too, right? If you were going to go into a pitch and you'd say the key is sales growth. Companies that are growing their sales are going to be the best companies out there and they're going to become the biggest companies out there. It would be

Starting point is 00:06:12 pretty compelling. However, when you look at the fullness of time, sales growth is one of the worst metrics to look at. It does worse than T-bills. So I knew that we had to have a long period of time to be able to see what truly worked over many market cycles. And yet everyone is almost always looking at not even five years, but three years. There's very little information in a three-year period. And so another goal with the book was to try to demonstrate to people, you're looking at the wrong time frame. You need a much longer time frame to see the efficacy of whether something works or not. So for anybody out there that has not read Jim's book, I cannot endorse this book enough, to be quite honest with you.

Starting point is 00:07:02 I rarely tell people that this is a mandatory read, but I will say that when you see the analysis and the amount of work that Jim has put into writing this book, you are going to be floored. You're going to be absolutely blown away. So I can make that recommendation unequivocally is go out and get this book because I promise you it's going to help you understand investing a whole lot more. And Toby has something that he wants to piggyback on that comment. I just wanted to add that when I first read it, I used it as an encyclopedia and went straight to the what works parts of it. And when I came to write quantitative value, I wrote it without the benefit of having read the first part of the book. I went and got the newest edition of what works when it came out. And I read the very start of what works.

Starting point is 00:07:45 And I really wish that I'd read that before I wrote quantitative value because I think that it canvases everything that we discuss in quantitative value and it does it in a really readable way. And I think that instead of buying quantitative value, you could just read the first portion of what works on Wall Street. And you get all of the same ideas that we were trying to cover in quantitative value. The ideas of sort of having some humility towards the application of the process and relying on the process and the reasons why you might want to do that because you make behavioral errors and we have cognitive biases. And I will also recommend your book, which I loved. I think that the more you read this type of information, the more it sinks in. And I think that we all should be able to look at the market. You know, you put it a little differently than I do, Toby.

Starting point is 00:08:31 But the more you read the books that explain why this works, what it comes down to is human nature. and our biases which are very difficult to overcome. We had Wes on the show, and he had a fantastic comment about basically front-running expectation and how you can do that with value, but it's exceptionally hard to do it with the quality metric, which a lot of people try to balance that value piece and the quality piece because they're trying to take after Warren Buffett. But Wes talks about how the quality piece is very hard for people to basically front-run that expectation where they're prone to do that or to punish companies more in the price,

Starting point is 00:09:13 and that's easier for value investors to capitalize on. And Wes had a fantastic discussion on that. If people want to go back and listen to our second part interview with Wes Gray, he does a fantastic job explaining that idea. But instead of focusing on that, I want to get to a question here for Jim. So you start off your book with this amazing quote, and I just love this quote that you have on the very start of the book. And then the quote reads, the Chinese use two brush strokes to write the word crisis. One brush stroke stands for danger, the other for opportunity.

Starting point is 00:09:47 And a crisis, be aware of the danger, but recognize the opportunity. And I just love this quote, and I think it's very fitting for the current market conditions just because of things are getting a little interesting out there. And so I guess my question for you, Jim, is what kind of opportunities do you think are out there today? And what new opportunities do you see really kind of presenting themselves over the next year? Within the United States, we're still getting excellent results buying cheap companies with high shareholder yield, where they're buying back their company's stock. I would say gingerly international markets and emerging markets, they've gotten tremendously cheap. For those bold enough to have a five-year time horizon, now is a good time to be looking at

Starting point is 00:10:35 those opportunities. Jim, when you say that they're cheap, we're comparing that relative to interest rates, which we have, I mean, my personal expectation is that if the Fed does raise rates, they're going to do it at such a minuscule level and they're not really going to be able to do it much more for a significant period of time. So that's really the predicament. That's where everyone in our audience is really concerned is how long. can they keep these interest rates low like this? And does that mean that these companies are actually

Starting point is 00:11:05 maybe buying at a high price point because interest rates aren't going to be able to adjust? And this thing's kind of unravel itself because of all the pressures we're seeing overseas. Well, you saw what happened when the Fed failed to raise rates. The markets sold off. The markets are expecting and anticipating the Fed to raise rates this year. And I'm not so certain that it will just be a minuscule adjustment. I think. think that basically the Fed could send a message that the U.S. economy is strong enough to normalize interest rates. Several things happen when that happens. A dollar goes up, making the emerging markets and foreign markets easier to export to the United States. So in a manner

Starting point is 00:11:49 of speaking, I think that sort of ringing the bell and saying, hey, the U.S. market is very strong right now. We're growing very well. Let's re-normalize. I think that if that happens, then it's very helpful for both international and emerging markets from an export point of view. Both Preston, I and Toby, and we read all the same books. We read everything that we could about or Buffett, who was really big on the microeconomic factors. But recently, given the current environment, we really be looking into some of the macroeconomic factors. And it seems to, you know, like it's also something that you are paying attention to. Well, we pay attention. We don't let it influence our models, right? So we use only data to inform our opinions. And so for a good example of

Starting point is 00:12:40 that was in March of 2009, I wrote a paper called a generational buying opportunity. And of course, all I heard was crickets. And I wrote that paper not because I was insightful in terms of a market bottom. I wrote that book because all the data I had available to me said that we were at an inflection point. The 10 years ending February 2009 were the second worst 10 years since 1870. And as quants, what do we do? We go back and look at all the other 50 worst 10 year periods and find out what happens afterward. Well, if you remove one year afterward and you look at 3, 5, 7, and 10-year returns, all were positive. We believe in probabilities, not possibilities. So that data was saying to us quite strongly that the probability of this occurring again was quite high,

Starting point is 00:13:38 and thus the paper. So while we're aware of macro events, we never let them override any of our models. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin to survive currency

Starting point is 00:14:25 collapse, using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to but end up having dinner with. Over three days, you'll experience powerful mainstage talks, hands-on workshops on freedom tech, and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June. If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at

Starting point is 00:15:11 Oslof Freedom Forum.com with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference. It's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we make AI useful in the real world? Because the upside is huge, but guessing your way into it is a risky move. With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI Cloud ERP, trusted by over 43,000 businesses. It pulls your financials, inventory, commerce, HR, and CRM into one unified system.

Starting point is 00:15:55 And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the Netsuite AI connector, you can use the AI of your choice to connect directly to your real business data. This isn't some add-on, it's AI built into the system that runs your business. And whether your company does millions or even hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide,

Starting point is 00:16:27 Dymistifying AI at net suite.com slash study. The guide is free to you at netsuite.com slash study. NetSuite.com slash study. When I started my own side business, it suddenly felt like I had to become 10 different people overnight wearing many different hats. Starting something from scratch can feel exciting, but also incredibly overwhelming and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify.

Starting point is 00:16:58 Shopify is the commerce platform behind millions of businesses around the world and 10% of all e-commerce in the U.S. from brands just getting started to household names. It gives you everything you need in one place, from inventory to payments to analytics. So you're not juggling a bunch of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions and even enhance your product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support. Start your business today with the industry's best business partner, Shopify, and start hearing... Sign up for your $1 per month trial today at Shopify.com slash WSB.

Starting point is 00:17:45 Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. So, Jim, your argument about being easier for foreign countries to succeed because the dollar is getting stronger, when we look at the U.S. companies, it's becoming harder for them in order to increase their top line and subsequently their bottom line because now the dollar's so much higher.

Starting point is 00:18:15 And when we look at how much revenue is being produced by outside sales and it's a huge portion of the top line in all these U.S. companies. So as we look at that dollar getting stronger, the Fed raising rates, and knowing that investors that are in the U.S. are trading off of a multiple of that earnings, if we see those earnings go down, you know, my impression moving forward is that the U.S. stock market is going to have a lot of trouble moving forward, especially going into the third quarter. I'm already hearing 5% decline in top line revenue the third quarter. So in the short term, and I know you don't like to talk short term, but in the short term, do you see the U.S. equity market really having some difficulty? You know, actually, I will be honest with you and say, I have no idea. I can tell you that we did a study looking at rising rate environments. and what we found was that high shareholder yield companies continued to do well.

Starting point is 00:19:15 Dividend companies did not do as well. So if that unfolds as I think it might, we would tell investors to focus more on shareholder yield, which includes buyback and dividend, and not just dividend alone. Just to follow up on this before, Jim, you also said that you pay attention to macroeconomics indicators, but you don't, they override the models that you're having. I also guess that you must include the macroeconomic factors like interest rate, for instance, in your models.

Starting point is 00:19:45 We do not include interest rates in our models. We do test in various environments how our models perform. So we have information available for rising rate environments, declining rate environments. We have models tested against stronger dollar, weaker dollar, but we're just doing that so that we can anticipate how our particular models are going to perform during that kind of environment. Jim, I have another question. After reading what works on Wall Street, you talk a lot about rebalancing.

Starting point is 00:20:19 Basically, that's the premise that we're working with because we want to rebalance into, say, the cheapest desal in price to earnings or the cheapest desal in price to sales. Now, a cost that it would occur if you're using that strategy is that you would have to pay commissions, you have to pay spreads and so on. There are always some transaction cost of doing that. So how do you access that? What is the optimal frequency if you think about that you're getting a higher return rebalancing frequently, but also higher costs? Well, we use something we call dynamic rebalance and we do it monthly. Now, obviously as a firm that's managing billions of our cost structure tends to be considerably lower than a individual investor.

Starting point is 00:21:06 But we think that the dynamic rebalance allows us to get into higher conviction names. So, for example, if Seagate technology shows up in all 12 sleeves, it ends up being like a 5% portion of the portfolio. Conversely, if a name only appears once and then no longer appears, it's de minimis in the portfolio. We have found this to be extremely helpful in terms of having the ability to both have higher conviction in certain names, but also lower conviction in other names. For an individual, I think there might be some firms out there that they could use. I'm thinking of some of the robo advisors, but monthly rebalancing a strategy, we have, found to be optimal. I think motif offers a similar service where it's very cheap to rebalance even in a very small portfolio. They'll allow you to buy fractions of shares.

Starting point is 00:22:05 So that's a, I use that just to test little strategies all the time. You can see a tiny little portfolio and then you can play around with it as much as you like. I don't get any money from for pitching that back to our regularly scheduled programming. So that's some really interesting information there. We'll definitely have more about motif in the show notes, kind of describing what it is and also the links to this if people were interested in learning more. That's awesome. Jim, your son, Pat, has been doing some incredibly interesting research that I've been following really closely. I think he's sort of picked up where you left off in the book. He's kind of doing it in a live way on his blog,

Starting point is 00:22:44 Investors' field guard, which will provide a link to. I find it really interesting that it is very difficult to kind of internalize some of these concepts for investors. You were saying earlier that you're happy putting that stuff out because someone will read it and then soon enough afterwards they abandon it in favor of something else. That's certainly not what Pat does. He's kind of stuck with it and he's doing, I think, some of the most interesting research out there at the moment. And he does it in real time. That's what makes it so useful. I just wondered how you kind have instilled in him that same ethos that you've got in the book. I've got little kids. I'd love them to sort of... Well, I did it by never telling him what to think. I did it by teaching him how

Starting point is 00:23:26 to think. There's a big difference there. And, you know, Patrick graduated from Notre Dame with a degree in philosophy, which I think was one of the best degrees he could have ever taken because it taught him how to think. Patrick always says that I was an incredible mentor to him, but that I never talked about things like price to sales or how to combine them do a better thing. He said he was struck by something I told him when he was 10 years old. And I said, the reason why our type of investing works is that we were deterministic thinkers in a probabilistic world. And he said, of course, at age 10, I had no idea what you're talking about. But as I got older and thought about that quote, he said, it made me really realize that life is probabilities. And what you

Starting point is 00:24:20 need to do to succeed is understand that and study what has the highest probability of success. And then go with that. What's interesting is I grew up in a family business where they pressured me, They really wanted me to work at this company, it was an oil company. And so one of the things that I did was do the opposite. I never told Patrick that I wanted him to work in finance. I told him he had to find what his own passion was. And that way he would have a very enjoyable life. And sure enough, got out of Notre Dame coming into Osam as an intern.

Starting point is 00:24:59 And it was funny because I said, I went to one of my senior guys and I said, Patrick has an end date. It's January 1st of 2008, and that's it. No, we don't want any nepotism. About two weeks later, the director of research and the president of my firm come into my office and they go, we have to hire him. So I thought that in those two weeks, he showed his medal. And as you say, the work he is doing right now is just incredible. And it's all for free, all at the Investors Field Guide. And really, it demonstrates to me something that I have always found important.

Starting point is 00:25:39 You've got to learn how to look at things in a way that others don't. There's a conventional approach to looking at things. And Patrick has a real gift for saying, well, what about this? How about looking at it this way? So I couldn't be prouder of the work that he's doing And, you know, he's a principal and a senior portfolio manager at the firm, and he's earned every bit of it.

Starting point is 00:26:08 That's awesome. I love that story. And I love the fact that this is your son that we're talking about. We'll definitely have a link. So for people, if they want to learn more about Patrick and the work he's doing, we'll definitely have that in the show notes as well. So, Jim, I've got a question for you because one of the things that Stig and I have seen in our audience is this huge interest in this quantitative value investing approach. And so if people are getting ready to implement this approach, kind of stepping away from maybe the Warren Buffett style and definitely stepping more towards this quant approach, what are the two biggest mistakes that you find a lot of investors make whenever they start doing this mean reversion style value investing strategy? Well, I think the first mistake they make is they never give it enough time to work.

Starting point is 00:26:54 And, you know, the minute you're looking at your portfolio on a daily basis, you're doomed because you're just not going to be able to stick it out. The second mistake they make is if, and this sounds odd, but if it works for them brilliantly for the first like six months, nine months, 12 months, they're going to walk around, strutting around like a peacock saying, oh, I know how to do this. This is fantastic. And that sets them up for the fail. The amount of time truly is the thing that I think is the greatest failure.

Starting point is 00:27:31 I mentioned earlier about the stocks with high sales growth having a great five-year period. What I would advocate if they have access to tools where they can test things over a long period of time, look at the long period of time that this particular strategy that they're using has and look at its ups and downs. follow a strategy that has a fabulous long-term track record and wait for it to have a bad six-month, one-year period, and then implement the strategy. It's the exact opposite of what most people do, and yet it works really, really well. So not focusing on having enough time, number one, and lacking the patience to let the strategy work. And then finally, not having the courage to see a strategy that has done very well, let's say, over the last 10 years and has done horribly over the last year, having the courage to go in

Starting point is 00:28:33 and buy it then. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up. And customers now expect proof of security just to do business. That's why Vanta is a game changer. Vanta automates your compliance. process and brings compliance, risk, and customer trust together on one AI-powered platform.

Starting point is 00:28:56 So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Ryder spend 82% less time on audits with Vantta. That's not just faster compliance, it's more time for growth. If I were running a startup or scaling a team today, this is exactly the type of platform I'd want in place.

Starting point is 00:29:28 Get started at vanta.com slash billionaires. That's vanta.com slash billionaires. Ever wanted to explore the world of online trading, but haven't dared try? The futures market is more active now than ever before, and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments, the S&P 500, NASDAQ, Bitcoin, gas, and much more. Explore equity indices, energy, metals, 4X, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone.

Starting point is 00:30:06 Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity, you'll be able to trade it in just two clicks once your account. is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited, risk-free demo account with charts and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit plus 500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus. Billion dollar investors don't typically park their cash in high-yield savings accounts. Instead,

Starting point is 00:30:52 they often use one of the premier passive income strategies for institutional investors, private credit. Now, the same passive income strategy is available to investors of all sizes thanks to the Fundrise income fund, which has more than $600 million invested in a 7.97% distribution rate. With traditional savings yields falling, it's no wonder private credit, has grown to be a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest in the Fundrise income fund in just minutes. The fund's total return in 2025 was 8%, and the average annual total return since inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025.

Starting point is 00:31:41 Carefully consider the investment material before investing, including objectives, risks, charges and expenses. This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right, back to the show. I just have a quick follow-up, and I know this wasn't something that we were planning on asking you. I'm just kind of curious. You're really the leading expert in this, and you really initiated this whole field of study. But who else out there do you really admire that are doing this? If you could name two or three people that are taking on this quantitative approach that you really kind of admire and you're quick to try to read anything that they come up with. Sure, Cliff Asness at AQR,

Starting point is 00:32:22 the folks at LSV. And then finally, not particularly quant, but I love the way he thinks, and it would be David Dreeman. He talks a lot more about why as human beings we fail in investing. And then Joel Greenblatt would be another one that I would have people read. His models tend to be a little more simple than ours, but a great read. So going back to what works on Wall Street, and I got to admit, James, I was a bit late to the party. I actually read it within the last few months. And the reason why I did that was because Toby forced me to. It's a very interesting way of distributing books nowadays, huh?

Starting point is 00:33:05 No, so all joking aside, I have this great. great chat with Toby and he said someone you should really get on the podcast that would be Jim Sjana say and you should really be reading what works on Wall Street first so I bought it and I got it home and it was really really big and as Jim said just before we started into you could also use it as a weapon so it's a big book and I'm as guilty as charts because I just saw the table of content so like this is the best strategy so I I probably looked up on page 500 and so, yes, I should do value factor one. So what you're actually doing was that you were combining multiple value factor into one single

Starting point is 00:33:49 factor. You were not only looking at priced earnings, but you're looking at price to book, price to earnings, price to sales, so on, and then combining it into one. Could you tell us about that process, but also how I can apply that as an investor? Sure. What we found when we were doing the previous editions of what works on Wall Street was that the horse race always was changing. Depending on what your end date was, it was either price to sales as the best single factor, more data and a different end date. It turned out to be EBITDA to enterprise value. And so I got the idea after reading a paper. What they did was they combined a couple of factors, and they referenced me. I thought, well, what would happen if we put together all of the really popular value factors?

Starting point is 00:34:39 And what happened was that we found that by combining them and then ordinarily ranking them, the average of all of them, we could outperform any single value factor 82% of all rolling 10-year periods. Because what happens is it's just like anything else. things fall in and out of favor, right? So one thing I like to say is when you see a lot of academic research on a single factor, expect that factor to fail over the next five years. Why not just put them all together, equal weight them, average, and get a better picture of the true value of a stock. You know, sometimes you'll see a company that has a super low PE ratio, but it's bad on every other factor, right? It's got very high price to sales ratio, very high on all of the other

Starting point is 00:35:33 value factors, and by combining them, that allowed us to see through. In addition to combining value factors, you combine momentum with those value factors. You do it in two with different ways. You have one that's predominantly value with some momentum, and then you have a predominantly momentum strategy that has some value in it as well. Can you talk about when you examine those two strategies, the sort of characteristics of the behavior of those strategies. And do you do them long, short as well? For momentum, for example, we found that by including volatility in our momentum composite, we could significantly reduce the volatility, but still take advantage of the momentum signal.

Starting point is 00:36:17 One of the big problems with momentum is it's very, very volatile. And so we thought, well, let's add a volatility index. and focus on the companies that are doing very, very well, but aren't bouncing around a lot. So there's an example of how we tried to correct the problems of momentum. After what we call almost a catastrophic bear market, which is a drop of 50% or more, momentum inverts.

Starting point is 00:36:47 And all of the stocks with the worst momentum do very, very well. And all of the stocks that had been doing well during the crisis, tend to do poorly. How much of that correlates to today's conditions, Jim? I think not very much. I think that we are in what I would call a normal market environment, you know, where people freak out when they get their 10% correction, which we've just had, but you don't remember the last one, which happened in 11. 10% corrections are a rule. You know, it's a feature, not a bug. What's different, though, of course, is how human beings behave. everybody says, I'm going to get back in the market.

Starting point is 00:37:28 It's just I'm waiting for that correction. And then the correction comes and they don't buy. So the one question that I've got is really moving forward, the question I ask a lot of bulls at this point is where's that growth going to come from? When we look at the upside and what that might be, and just so you know, have some context, I'm a huge bear in current market conditions. I'm curious, if you are a bull, where are you seeing that growth comes? coming from, how are these companies actually going to increase their top line and subsequently their bottom line whenever we're in a condition where the dollar is really going to only get stronger if the Fed does make that decision to act? And even if they don't, it seems like

Starting point is 00:38:08 external forces are going to continue to put that pressure into the market. So I'm curious where you're seeing upside, outside of buybacks for companies to increase their EPS. We're very rarely either extremely bullish or extremely bearish. And that's because we think for the long term, and we also realize that our ability to forecast what's going to happen over the next quarter or over the next six months is nil, right? We know how little we know. Power of I don't know is very good, and it allows people to focus on what their true goals are. So I don't know what the market's going to do over the next quarter or half a year,

Starting point is 00:38:50 but I do know what the market's going to do over the next 10 years. and I think it's going to do very, very well. So the problem is unless circumstances are just so catastrophic like they were in March of 2009 or so euphoric. So we tend to just have a normal, even keel approach to looking at investing. We try to remind all of our clients that what is your time horizon? That's what you need to focus on. Would it be safe to say that when you look at equities versus bonds at this point,

Starting point is 00:39:23 you're really seeing equities with about a 4% yield over the next 10 years and fixed income 10 year treasuries around 2%? Is that you're seeing that spread and that's why you're still bull on equities? Would that be a safe assessment? That's a fair assessment. I think that I also wrote another paper that didn't come true, which was a generational selling opportunity for long bonds. I wrote that a couple of years ago and ultimately we are very bearish on bonds, particularly

Starting point is 00:39:50 long bonds. We think that investors who are not over the age of 50 have never experienced a bond market that was bearish. And I'm 55, so I remember interest rates of 14, 15 percent in the early 80s. That was a, I guess, 35, 40-year bear market in bonds. You know, bonds are math. Interest rates start going up. Holders of the current bonds are going to experience price declines. I think that, yeah, In terms of a 2% yield on the 10-year and you get a 4% yield on equities, I'm willing to take the risk on the equity side. Fantastic. One of the most important questions we like to ask our guests is what books have really had the biggest impact on your investing career? If you could just name a couple of those books and why they had such significant meaning to you, that'd be really awesome.

Starting point is 00:40:42 Sure. Well, reminiscence of a stock operator, the story, thinly veiled story of Jesse Livermore. is as true today as it was when it was written. The quotes in there are incredible, and they apply so much today as they did that. A cautionary tale. Livermore ended up committing suicide in the Sherry Netherland Hotel in the mens room

Starting point is 00:41:05 because he could not follow his own systems with a rigorous, unemotional approach. Obviously, Ben Graham, I think you should read all of the stuff Ben Graham has ever written. And he's really the father of value investing. He was also the first to take a systematic approach to saying, let's get a checklist. Let's make sure the stocks have this, this, and this, and then we'll buy. If they don't have all those things in place, we're not going to buy it.

Starting point is 00:41:36 We're going to be patient. We're going to wait. I really, really love that you're saying that, James. And I think it's such a strong part that you need to be humble. I think that the worst investment books that you can probably. get, it's those investment books that really makes you think you that you're smart. And I think that's one of the problems with a lot of the beginning investing books that you kind of think that after reading that book, yes, you really got that figured out. And let me tell you,

Starting point is 00:42:00 folks, there is no one investment book, has everything worked out for you? That's a painful lesson for all investors. And I would definitely suggest one of James's book recommendations as one of the first books to read when you ever start investing, just really to get humble and really to get started on the right track. We always try to say that we are wise in the Socratic sense of knowing how little we know. And if you think that you are smarter than the market, you are wrong. The market is always smarter than you. And Toby, you even talk about that idea with Ben Graham really kind of coming to that culmination right before his death,

Starting point is 00:42:39 talking about that same idea where, hey, I've just got to basically remove myself from this because I'm really kind of the air at play. and I have to basically just do it off of pure data. Now, we've seen Buffett obviously hasn't implemented that approach, but it's just a really interesting point that on Ben Graham, after he had written all this, is basically like, hey, you need to remove yourself and your biases towards selecting which metrics you like the most and really kind of leave it up to the data to close us out.

Starting point is 00:43:05 And Toby talks about that in deep value at the end of his book. So, Jim, we can't thank you enough for coming on the show. You don't know how much this means to us personally. And I sincerely mean that. It really means a lot to us. for you to take an hour out of your day on a weekend to talk to us and just impart your knowledge to our audience. For everybody out there listening, the name of Jim's book is What Works on Wall Street,

Starting point is 00:43:28 we highly encourage you to go out and get this book. And when it arrives, you're going to be amazed at how much knowledge and how much depth he has in this book. You're going to be blown away. I promise you that. Toby Carlisle, he has a website called The Acquires Multiple. He has two books, deep value, quantitative value also on the podcast. and you can see Toby's brilliance with some of his questions as well.

Starting point is 00:43:49 We just really want to thank both of you for coming on the show. And that's all we have for you. Great. My pleasure. Have a great Sunday. So that's all we have for you guys this week. We really appreciate you tuning in. Make sure you check out our show notes so you can get a link to all these different topics and ideas that we were talking about.

Starting point is 00:44:05 If you guys sign up on our list, you'll get our free book summaries that Stig and I do for each book that we read. They could potentially add a whole lot of value because you can cut out a lot of time on your reading. Our summaries are typically around five pages. We don't charge anything for this. So just sign up on our email list. We don't send any advertisements or spam through our email. We only send two emails every month. So all the books that we read, we do it through audibles.

Starting point is 00:44:29 We highly recommend that people use the link on our website to access your account on audibles because if you do that, you'll get your first book for free if you use the link through our website. So go ahead and check out those links. It's on our tools or any of the web pages where you can click on that link for audibles. and that's how we read all of our books. So we'd just like to thank everyone in our audience for joining us, and we'll see you guys next week.

Starting point is 00:44:52 Thanks for listening to The Investors Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www. www.theinvestorspodcast.com. Submit your questions or request a guest appearance to The Investors Podcast by going to www. www.com. If your question is answered during the show, you will receive a free autographed copy of the Warren Buffett Accounting

Starting point is 00:45:15 book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP network and must have written approval before a commercial application.

We Study Billionaires - The Investor’s Podcast Network - TIP 057 : What Works On Wall Street with James O'Shaughnessy (Business Podcast)

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.