Who is James P. O’Shaughnessy?
O’Shaughnessy is Chairman, Chief Investment Officer and Portfolio Manager at O’Shaughnessy Asset Management. O’Shaughnessy focuses onquantitativeequity analysis,portfoliomanagement, research decisions, and investment modeling. He is the author of several books, including the bestselling “The Best Investment Strategies of All Time” – What Works on Wall Street. In his investment style, O’Shaughnessy combines momentum and valueinvesting with fundamental criteria. He called the investment strategy the Trending ValueStrategy. O’Shaughnessy has received several US patents for his investment strategy and has been recognized by Forbes.com as a legendary investor.
Biography
James P. O’Shaughnessy was born on May 24, 1969 in Saint Paul, Minnesota. He attended Saint Thomas Academy as a teenager. Even as a young person, he was interested in the stock market and in analyzing stocks, for example, he examined the companies in the Dow Jones Industrial Average stock index for common characteristics. O’Shaughnessy graduated from the University of Minnesota in 1986 with a Bachelor of Arts degree in economics. O’Shaughnessy initially worked for a family venture capital firm. A colleague drew O’Shaughnessy’s attention to the fact that the findings of O’Shaughnessy’s research could also be of interest for the management of pension funds. O’Shaughnessy therefore founded O’Shaughnessy Capital Management in 1988. The company advises large pension funds and foundations.
Due to his interest inquantitativeanalysis, O’Shaughnessy continued his research.
He wrote several books:
- “Invest Like the Best: Using Your Computer to Unlock the Secrets of the Top Money Managers”, 1994
In German this means something like: “Invest like the best: Use your computer to unlock the secrets of the best money managers“. - “How to Retire Rich: Time-Tested Strategies to Beat The Market and Retire in Style”, 1998
“How to Retire Rich: Proven Strategies to Beat the Market and Retire in Style” - The bestseller – with the 1st edition in 1997 – is and remains: “What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time”
In German, this work is known as “Die besten Anlagestrategien aller Zeiten – Welche Investment-Methoden wirklich funktionieren”.
Further key professional data:
- 1996 – O’Shaughnessy founded his own investment funds: Cornerstone Growth and Cornerstone Value.
- 1997 – RBC O’Shaughnessy Mutual Fund is launched by the Royal Bank of Canada for Canadian investors. There are currently seven investment funds in the RBC O’Shaughnessy fund family.
- 1999 – Foundation of Netfolio: Netfolio enables private investors to build their own diversified portfolios via the Internet. The company was closed in 2001.
- 2000 – O’Shaughnessy Capital Management sells the investment fund family to Hennessy Advisors.
- 2001 – O’Shaughnessy and his team move from O’Shaughnessy Capital Management to Bear Stearns Asset Management (BSAM), where O’Shaughnessy was Senior Managing Director and Executive Director of Systematic Equity.
- 2007 – O’Shaughnessy agrees with Bear Stearns to spin off its Systematic team from BSAM and form O’Shaughnessy Asset Management, LLC.
How does the Trending Value strategy work?
O’Shaughnessy is the inventor of the Trending ValueStrategy. In the fourth edition of his bestseller “What Works on Wall Street”, James O’Shaughnessy has developed a new idea that he describes as “the best stock market strategy of the last 50 years“. Instead of focusing on one specific key figure, he ranks companies according to 5-6 key figures and combines this with a momentum factor.
First, the companies are analyzed using the following key figures and divided into 100 groups (percentiles). The six key figures are briefly explained below before the trendingvaluestrategy is discussed further.
Price-to-book ratio
The price-to-book ratio is used to compare the market capitalization of a company with its book value. It is calculated by dividing the company’s share price by its book value. Price-to-book ratios below 1 are generally considered sound and favorable investments. However, there can be differences depending on the sector.
Price/sales ratio
The price/sales ratio is a valuation ratio that compares a company’s share price with its revenue. It is an indicator of the value that the financial markets attach to each franc of a company’s revenue.
EBITDA/enterprise value (EV)
TheEBITDA/EV multiple is a financial valuation metric that measures a company’s return on investment (ROI). The EBITDA/EV ratio may be preferred over other measures of returnbecause it adjusts for differences between companies. Using EBITDA adjusts for differences in capital structure, taxation andaccounting forfixed assets. Enterprise value also adjusts for differences in a company’s capital structure.
Price/cash flow ratio
The price/cash flow ratio is a stock valuation indicator or multiple that measures the value of the share price in relation to its operating cash flow per share. The ratio uses operating cash flow (OCF), which includes non-cash expenses such as depreciation and amortization to net income. The price/cash flow ratio is particularly useful for valuing stocks that have a positive cash flow but are unprofitable due to high non-cash expenses. This is in contrast to thediscountedcash flow method where free cash flow is used – also known as free cash flow (FCF).
Price-earnings ratio
The price/earnings ratio is the ratio of a company’s valuation that measures the current share price in relation to earnings per share (EPS).
Shareholder return
Shareholder returnis a measure of financial performance that indicates the total amount an investor earns from an investment, particularly from shares or units: Either through share buybacks, dividends or the repayment of debt.
Calculation Trending Value Strategy
The calculation and classification of the Trending Value strategy works as follows: Each company is classified according to the above valuation ratios and then a combined ranking is calculated for the company.
For example: If the price/sales ratio of a company is among the lowest 1 % of the data set, it is given a price/sales rank of 1. A low value means that an investor can expect a comparatively high turnover for an investment of one franc. However, if the company has a price/sales ratio that is among the highest percentage of all companies in the data set, the company is given a price/sales rank of 100. The same calculation is repeated for each of the key figures.
The reverse is true for some key figures, for example EBITDA/EV: if a company is in the top 1%, it is also ranked first for this key figure.
Each company therefore receives a percentile rankingfrom 1 to 100 for each KPI. If a value is missing, it receives a score of 50, which represents the middle of the ranking and is therefore neutral. Once all companies have been ranked in terms of all evaluation indicators, all values of the evaluation indicators are added up for each company. All companies are then ranked in percentiles from 1 to 100 in this combined ranking. This final result is called the ValueComposite. A Value Composite of 1 means that the company is among the 1% most favorable companies according to these factors.
In a second step, the top 10 % of companies are selected, which are classified according to this value composite score. The shares are then sorted according to a momentumfactor, in this case the 6-month price index. This indicates how the share price has performed over the last 6 months.
The result is an extremely favorable group of companies that have risen in the last 6 months.
Does the Trending Value Strategy really work?
O’Shaughnessy tested 3 different value composite scores (VC), each based on different criteria:
- Value Composite 1 (VC1): Based on the first 5 metrics only, excluding shareholder return. Using this metric, his backtests showed an annualized return of of 17.18 %.
- Value Composite 2 (VC2): Based on all 6 metrics. O’Shaughnessy uses this metric in his trended value screening as his backtests showed a 12 basis point improvement in annual total return to 17.3%, lower standard deviation and lower downside risk.
- Value Composite 3 (VC3): Works like the Value Composite 2, but the last metric is replaced by the buyback yield. Some investors are indifferent to whether a company pays adividend or want to avoid them as they can be very highly taxed. This Value Composite achieves an even higherreturn of 17.39% per year, albeit with a slightly higher standard deviation compared to the Value Composite 2.