Book Summary Preview : What Works on Wall Street

The Big Idea
It is amazing to reflect how little systematic knowledge Wall Street has to draw upon as regards the historical behavior of securities with defined characteristics. We do, of course, have charts showing the long-term price movements of stock groups and individual stocks. But there is no real classification here, except by type of business. Where is the continuous, ever growing body of knowledge and technique handed down by the analysts of the past to those of the present and future? When we contrast the annals of medicine with those of finance, the paucity of our recorded and digested experience becomes a reproach. We lack the codified experience which will tell us whether codified experience is valuable or valueless. In the years to come we analysts must go to school to learn the older established disciplines. We must study their ways of amassing and scrutinizing facts and from this study develop methods of research suited to the peculiarities of our own field of work. - Ben Graham, 1946

What Works on Wall Street, by James P. O'Shaughnessy has been around only since 1998, but has already been hailed as one of the great classics of investment. O'Shaughnessy was the first person not an employee of Standard and Poors to gain access to the S&P Compustat Database, the most important and complete repository of fundamental and technical stock data in the world. The project that inspired this book was to computer backtest the data using various fundamental formula searches in order to find out what styles of investment have actually made profits in the last 50 years or so. It is a huge book, 366 pages long, so this little summary here hardly does it justice. This book is not just good, it is downright momentous, an amazing book that cuts through a century of Wall Street lore to show exactly what techniques pay off, you absolutely must get a copy and read it!!! In very brief form, this is what O'Shaughnessy found.

Small capitalization strategies owe their superior returns to microcap stocks with market capitalization below $25 million. These stocks are too small for virtually any investor to buy.

Buying stocks with low PERs is most profitable when you stick to larger, better known issues.

Price-to-Sales ratio is the best value ratio to use for buying market-beating stocks.
Last year's biggest losers are the worst stocks to buy this year.
Last year's earnings gains alone are worthless in determining what the stock will do this year.

Using several factors dramatically improves investment performance.
You can beat the S&P 500 by four times if you concentrate on large, well-known stocks with high dividend yields.

Relative strength is the only growth variable that consistently beats the market.
Buying the most popular issues with the highest PERs is one of the worst approaches.
Risk is one of the most important elements to consider in a strategy.
Combining growth and value strategies is the best way to improve your investment performance.

Index funds
Indexing is a great way to achieve very good investment results because it sidesteps flawed decision making and psychological traps. The S&P beats 80% of managed funds in long term returns. Indexing is a disciplined bet on large capitalization stocks. As these are the stocks that attract the lion's share of investment attention and investment funds, it is perfectly logical that they provide returns that are on average equal to the returns of the stock market. . . . . . . . . . .

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