Invest Using the Strategies of Wall
Street Legends
Learn to Leverage the Proven Stock Selection
Methodologies of Investing Greats
John P. Reese
CEO and Founder
Validea.com
Validea Capital Management, LLC
T: 860-519-5140
E: [email protected]
How do you pick stocks?
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Who here has a strategy for stock
selection?
How many of you deviate from that
strategy and let your emotion get the best
of you?
How many of you are unsure of what
values you should look at (i.e. P/E ratio,
EPS Growth or P/B) when evaluating a
stock?
For those who dont have a strategy is it
because you dont know what strategy to
follow?
The Story Behind Validea.com &
Validea Capital Management
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MIT and Artificial Intelligence
Research & Harvard Business School
Sold first technology company and
proceeded to invest in stocks
Took computer and stock knowledge
and combined them to found Validea
Awarded two U.S. patents in area of
Automated Stock Analysis
Other Interesting Developments
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Authored the book The Market Gurus:
Stock Investing Strategies you can use
from Wall Streets Best
Columnist for Forbes.com and
TheStreet.com. Former participant in
MSN Moneys Strategy Lab
SEC registered capital management
firm Validea Capital Management,
LLC. (currently $90 million under
management)
Underperforming is the norm
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80%-90% of all professionals fail to
outperform the market over long
periods of time (10 or 15 years).
Most professionals underperform by
1%-2%, while individuals
underperform by 2%-8%
Most experts are only right with
their predictions 20% of the time*
*Source: Ditch the Experts,
Fortune, Feb. 6, 2006
But
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There are a handful of investors
who have proven, either through
extensive back testing or real world
results, that they can deliver
returns that beat the pants off the
market.
What if you knew who these
individuals were? Well, we do!
Who: At Validea we follow numerous
guru strategies:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Peter Lynch
Ben Graham
Warren Buffett
Ken Fisher
David Dreman
Martin Zweig
James O'Shaughnessy
John Neff
William O'Neil
Joseph Piotroski
Why: Most Have Long Term Market
Outperformance Real World or Back
Tested
Guru
Performance
Peter Lynch
29% p.a. for 13 years
Warren Buffett
24% p.a. for 32 years
Martin Zweig
Ranked #1 newsletter
by Hulbert on risk-adj.
basis for 15 years
(15.9% p.a. over 15
years)
James OShaughnessy
Backtest Stats of 22%
p.a. over 40 years
Joseph Piotroski
Backtest Stats of 23%
p.a. over 20 years
David Dreman
16.6% over 11 years
Why were they selected?
Each one of these gurus has:
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1) developed a framework to select
stocks that has delivered market
outperformance
2) publicly disclosed these techniques
either in books, academic papers or
other sources
3) created a quantitative
methodology that can be leveraged
using a computer program
Methodology Example, David Dreman
Key Investing Criteria:
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Look in the universe of the largest cap stocks
(1500 largest companies)
Look for a contrarian indication:
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Look for a low price-earnings (PE), price-cash
flow (PCF), price-book (PB) and price-dividends
(PD) ratios bottom 20% of market
Earnings and Financial Criteria:
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Look for an increasing earnings trend in past 2
quarters
Look for EPS growth in the immediate past and
projected future to beat market
Dreman Methodology Example Cont
Look at the financial ratios.
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Strong current ratio (> industry)
Lower payout ratio than its historical average
High return on equity (ROE) (top 33%)
Pretax profit margins (>8%)
High dividend yield (at least 1% over market)
Low debt-equity (DE) ratio (<20%)
Do the written strategies of legends
still work today?
Yes!
Valideas Model Portfolios Based On
Value Strategies - Large Excess Returns
over S&P
Portfolio
Based On Inception
Date
Model
Ret p.a.
S&P
Ret p.a.
Excess
Ret. p.a
Contrarian
Investor
David
Dreman
7/15/03
27.8%
9.8%
18.0%
Value
Investor
Benjamin
Graham
7/15/03
27.5%
9.8%
17.7%
Book/Market
Investor
Joseph
Piotroski
2/27/04
20.4%
7.4%
13.0%
Low PE
Investor
John
Neff
1/2/04
14.8%
8.0%
6.8%
p.a. = per annum
Source: Validea.com Portfolio Performance (as of 8/31/2007)
Valideas Model Portfolios Based On
Growth & GARP Strategies - Large
Excess Returns over S&P
Portfolio
Based On Inception
Date
Model
Ret p.a.
S&P
Ret p.a.
Excess
Ret. p.a
P/S
Investor
Ken
Fisher
7/15/03
26.8%
9.8%
17.0%
Growth
Investor
Martin
Zweig
7/15/03
26.2%
9.8%
16.4%
G/V
InvestorB
J. OShaughnessy
7/15/03
24.4%
9.8%
14.6%
P/E
Growth
Peter
Lynch
7/15/03
21.7%
9.8%
11.9%
p.a. = per annum
Source: Validea.com Portfolio Performance (as of 8/31/2007)
Why Do They Still Work Today?
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Human emotion prevents many from
following these strategies (drawdowns,
bubbles and other reasons). Concept of
ever-changing cycles
There are certain variables that have
proven over time that they show a
predictive capability to select
outperforming securities on the whole
Why Do They Still Work Today?
We use a computer program that is
non-emotional and sorts through the
entire market of liquid stocks, not just
the stock of the day
Do they work in a Bear Market?
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Each strategy has proven, either through
back test or real world performance, to
have great returns over long term (through
Bull & Bear Markets)
Select fundamentally sound stocks:
companies need to be profitable - avoided
the highly speculative type stocks in late
1990s and Internet boom
Can you blend these strategies
together for better risk adjusted
performance?
Yes!
Validea Hot List (Consensus Approach)
vs. S&P 500
Hot List =
170% Return
S&P =
47.3% Return
Source: Validea.com Portfolio Performance (8/31/07)
Validea Capitals Consensus Models
Actual Money Management Results
Actual Results (net)
Model Portfolio
2007 (8/31/07)
2006
2005
International
10.1%
42.4%
25.2%
Consensus
7.8%
18.2%
18.2%
High Yield
7.4%
35.7%
25.0%
Conservative
4.3%
29.5%
5.4%
Balanced
2.3%
10.3%
8.2%
LT Value
6.8%
21.3%
N/A
LT Growth/Value
11.1%
12.1%
N/A
S&P 500 Index
5.2%
15.8%
4.9%
Actual Returns are presented based on a representative client account that was invested in exact accordance with the specified model without deviation. Returns
for all models, except the International Model, cover the period from January 1, 2005 December 31, 2005, January 1, 2006 December 31, 2006, January 1,
2007 August 31, 2007 and are not annualized. Returns for the International Model cover the period May 19, 2005 December 31, 2005, January 1, 2006
December 31, 2006 and January 1, 2007 August 31, 2007 and are not annualized. Figures, which are time-weighted total returns including dividends, are
reported net of accrued advisory fees and brokerage commissions at the highest fee level (total fees for advisory services and commissions range from 1.15%
1.7% of assets per year depending on account size). Returns do not include any investment restrictions. The S&P 500 has been selected as the relevant benchmark
because it is the most widely followed benchmark of the overall US market and is most often used by clients for return comparison purposes. Past performance
does not guarantee future results. Investors may incur a loss despite a past history of gains. Results will vary with economic and market conditions. A full list of all
individual recommendations that comprise this composite performance is available upon request.
Other Key Pillars In Strategy
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Rebalance
Long Term
All Cap
Emotion
Portfolio
Construction
Frequent Rebalancing (opportunity cost of
not selling & best performance)
You need to stick to strategy for the long
term
Look for opportunities across all market
segments
Remove emotion from the equation
Hold baskets of 10, 20 or 50 stocks
Equally weighted portfolio i.e. with a 20
stock model each holding accounts for 5% of
portfolio
Redefining Long Term Investing with
Frequent Rebalancing
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Rebalancing (opportunity cost of not selling
& best performance).
Annualized Performance since 7/15/03
Rebalancing
Period
Rebalance
Long Term
All Cap
Annually
Quarterly
Monthly
10 Stock Model
(avg. p.a)
15.5%
19.5%
21.4%
Emotion
Portfolio
Construction
Source: Validea.com 8/31/2007
Redefining Long Term Investing
Rebalance
Long Term
All Cap
Emotion
Portfolio
Construction
Dont have to hold onto stocks for the
long term to be a long term investor
goes against conventional wisdom
Hold onto the strategies for the long
term not the stocks
Buy and Hold strategies, in our testing,
fail to produce the best returns
To Be Successful You Need To Stick To
The Strategy, Even After Down Years
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Rebalance
Long Term
Seminal Study by Joel Greenblatt in The
Little Book That Beats the Market.
Greenblattt is the founder of Gotham Capital
1 Year
Period
2 Year
Period
3 Year
Period
Underperformed
25% of
the time
Underperformed
17% of
the time
Outperfor
med 95%
of the time
All Cap
Emotion
Portfolio
Construction
Source: Joel Greenblatt, The Little Book That Beats the Market (John Wiley
& Sons, Inc., 2006)
Behavioral Finance:
Removing Emotional Barriers
Biases
Self Deception
Heuristic Simplification
Social Interaction
Overoptimism
Representativeness
Emotion
Imitation
Overconfidence
Framing
Mood
Contagion
Self Attribution Bias
Categorization
Self-Control
Herding
Confirmation Bias
Anchoring
Ambiguity Aversion
Cascades
Hindsight Bias
Availability Bias
Regret Theory
Cognitive Dissonance
Cue Competition
Conservative Bias
Loss Aversion
Rebalance
Long Term
All Cap
Emotion
Portfolio
Construction
Source: David Hirschleifer, Investor Psychology and Asset Pricing,, Journal
Of Finance 56 (2001), Dresdner, Kleinwort Wasserstein Research
Behavioral Finance: Investor Biases
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Over Optimism: We are overoptimistic with our
estimate of how we can do and to find good stocks
Overconfidence: Overconfident that your judgment is
always right and creates and illusion of control and
knowledge.
Anchoring: Peoples tendency to give too much
credence to their most recent experience and to show
reluctance to adjust to their current beliefs.
Rebalance
Long Term
All Cap
Emotion
Portfolio
Construction
Loss Aversion: Fear of losing money and subsequent
inability to withstand short term events and maintain
a long term perspective
Buffett Quote on Emotions & Discipline
Investing is not a game where the guy with the 160
IQ beats the guy with the 130 IQOnce you have
ordinary intelligence, what you need is the
temperament to control the urges that get other
people into trouble in investing.
"To invest successfully does not require a stratospheric
IQ, unusual business insights, or inside information.
What's needed is a sound intellectual framework for
making decisions and the ability to keep emotions
from corroding the framework.
Rebalance
Long Term
All Cap
Emotion
Portfolio
Construction
Warren Buffett, Chairman Berkshire Hathaway
A Few Top Rated Stocks on
Validea.com
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David Dreman Strategy
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Peter Lynch Strategy
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APPLIED INDUSTRIAL TECHNOLOGIES
(AIT)
Warren Buffett Strategy
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CHEVRON (CVX)
JOHNSON & JOHNSON (JNJ)
Martin Zweig Strategy
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INFOSYS TECHNOLOGIES (INFY)
Full Disclosure: John Reese and his clients are long all four stocks
Final Thoughts and Takeaways
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No one best strategy -- Several strategies are
successful long term in the market
They dont just work by themselves scanning
7000 stocks, frequent rebalancing, not cherry
picking, blending strategies to improve risk
adjusted return
Based on what these gurus have done, they
have returned 15% - 29% average per year
By following the implemented strategies, you
give yourself a very good chance of long term
market outperformance
A resource, Validea, exists to help you select
stocks using those strategies.
Q&A & Contact Info & More
Questions or Comments:
[email protected][email protected](860) 656-0383
Web Sites of Interest:
www.validea.com
www.valideacapital.com
Thank You!
These Models Have Worked in the
Long Term, But How About Last Year?
2006 Validea Model Performance
vs. the Market.
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Fisher model up 40.0%
Dreman Contrarian Model up up 34.3%
Graham Value Model up 26.0%
OShaughnessy Model up 24.0%
S&P 500 up 15.8% (w/dividends)
