Trending Value: Breaking Down a Proven Quantitative Investing Strategy

$10,000 invested into the trending value strategy in 1963 became over $69M in 2009. The strategy was published in 2011 and has continued to work since.

What I’m about to introduce to you is not black magic. And I say that because if you’re a realist like me, anytime someone comes to you with something that sounds too good to be true, it’s almost always too good to be true (or a pyramid scheme). Update: see my post attempting to answer the skeptics.

But this strategy is rigorously backtested and rooted in common sense. It isn’t about finding correlations between obscure financial metrics and stock performance to formulate a otherwise seemingly random strategy.

Every metric in this strategy is commonly used by millions of investors every day; but when they are combined in a specific way, the results can be extraordinary.

Nominal Return, Trending Value vs All Stocks (1964-2009)
Nominal Return, Trending Value vs All Stocks (1964-2009)
The trending value strategy was developed by James O’Shaughnessy and detailed in his book What Works on Wall Street as one of the best performing strategies, using a combination of value and growth metrics, terms you’ve probably heard of or seen marketed in ETFs or mutual funds.

Value investing is a well-known investment strategy that aims to select stocks that the market has undervalued – that is, the stock’s price is lower than what its fundamentals suggest it is actually worth.

O’Shaughnessy begins by backtesting strategies using one value metric at a time. For example, a strategy that is only invested in the stocks in the top decile (lowest 10%) of price-to-earnings ratios (P/E) and rebalanced every year. And likewise using price-to-book ratio (P/B), price-to-sales ratio (P/S), and price-to-cash flow ratio (P/CF). He also looks at enterprise value to EBITDA (earnings before interest, taxs, depreciation and amortization) ratio (EV/EBITDA), which was the single best performing value factor he backtested. (For each of these 5 factors, low values are better).

Another factor he looked at was shareholder yield (SHY), which is buybacks (how many stocks are repurchased by the company (i.e., decrease in number of outstanding shares)) plus dividends divided by market capitalization. (For shareholder yield, higher is better). The results for the top decile of these factors (lowest (or highest for SHY) 10%, rebalanced annually) are below (with all stocks for comparison).

Performance of the Top Deciles of Various Value Factors of the Trending Value Strategy (1964-2009)
Performance of the Top Deciles of Various Value Factors of the Trending Value Strategy (1964-2009)

By themselves, all of these factors beat the overall stock market. But combining the factors, coming up with a composite score and investing in the top decile of composite scores, yields even better results. To develop the composite scores, a ranking for each factor is given to each stock in the universe of stocks. So the stock with the lowest P/E gets a score of 100, the stock with the lowest SHY gets a 1, and so on (this can be done with the PERCENTRANK function in Excel (or 1 – PERCENTRANK for SHY, since higher numbers are better), or much more seamlessly using a more powerful tool like Portfolio123).

The ranks for each factor of a stock are added up for its composite score. O’Shaughnessy looked at 3 different value composite scores: value composite 1 (VC1) used the factors described above except SHY, value composite 2 (VC2) add SHY to VC1, and value composite 3 replaces SHY with just buyback yield. The returns for top decile of each of these composite scores is below (rebalanced annually).

Performance of Value Composites VC1, VC2, and VC3 (1964-2009)
Performance of Value Composites VC1, VC2, and VC3 (1964-2009)

Each value composite is a significant improvement over any individual factor. Composites are more powerful than just screening for the best values of the individual factors because a stock that may be deficient in one metric but excellent in the others would get eliminated from consideration by screening (e.g., a stock in the top decile of VC2 may not necessarily be in the top decile for all of the individual factors).

To implement the trending value strategy, you simply invest in the top 25 stocks sorted by 6-month % price change (the “trending” part of the name) among the top decile of stocks ranked by VC2 (O’Shaughnessy chose VC2 over VC3 because of its slightly higher Sharpe ratio, a measure of risk-adjusted return).

The universe of stocks is limited to those with a market capitalization of more than $200M (in 2009 $) to avoid liquidity problems with trading smaller stocks. It’s a buy and hold strategy that is rebalanced annually with the following exceptions. If a company fails to verify its financial numbers, is charged with fraud by the Federal government, restates its numbers so that it would not have been in the top 25, receives a buyout offer and the stock price moves within 95% of the buyout price, or if the price drops more than 50% from when you bought it and is in the bottom 10% of all stocks in price performance for the last 12 months, the stock is replaced in the portfolio.

So what’s the catch? There are a few:

  1. The Data: While most of the metrics described are freely available from any number of online sources, some (e.g., buyback yield) aren’t as easy to come by, and I still haven’t found a free way to obtain all of the data for all of the stocks at once.
  2. Psychology: While the trending value strategy has never underperformed the market for any rolling 5-, 7-, or 10-year periods between 1964 and 2009, it has underperformed the market for rolling 1-year periods 15% of the time, and 3-year period 1% of the time. If you hit a few years with less-than-stellar performance, are you going to stick it out and trust the strategy, or are you going to jump ship to bonds (as many people did in 2009, missing out on the huge subsequent rebound) or another trendy strategy that seems to be performing better at the time?
  3. Commissions (for small-time investors): At $10/trade and 25 trades per year, you need a portfolio of $100,000 to keep your commissions to a reasonable 0.25%.
You can learn how to implement the trending value strategy here, so number 1 is solved. Number 2 is on you. And number 3 is covered here.
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24 Replies to “Trending Value: Breaking Down a Proven Quantitative Investing Strategy”

  1. The most reasonable price I've found is Portfolio123 (link at the top of my sidebar). You can create custom formulas and rankings for everything you need, and there's an active community to help answer questions. Not free, but worth the cost if you utilize its potential. They have a 15 day free trial to test it out (which is what I did before deciding to subscribe).

    You can get most of the data you need from finviz ( except buyback and you can't export the data unless you pay.

    I found that Fidelity's stock screener has most of the data (except buyback), and you can export it 200 stocks at a time (the universe will be in the thousands, so it'll take some time), but you need to have an account on Fidelity. I'm sure other brokers have similar tools.

    Meb Faber lists some other free data sources here: I have not looked into them, with the exception of Quandl, which seems promising, but again most of the good datasets were not free.

    I hope that's helpful; access to the data is one of the major hurdles to these strategies, and part of what I wanted to do was publish the stock signals for various strategies so that people without access to data could still implement them.

  2. i bought the book and a trial at portfolio123. The book is easy to read and the principle is clear. However it became quite complicated to apply the ideas to the data.

    The rules I implemented into portfolio123 to get the value composites were as follows:


    then I conducted the screen and wanted to export the data to excel so that I can analyse them, however I get only weird unsorted colums that are full of dates and missing values.

    Do you know how to solve this problem?


  3. You need to create a ranking system for Value Composite 2 using those factors, and another ranking system for 6 month % change. Then in your screen, the buy rule will be rating(“VC2”) > 90, and the screen ranking system will be 6 month % change.

  4. Okay, to be shure, price-to-book, price-to-earnings, price-to sales and price-to-cash flow receive a lower rank when the number is high, whilst Ebitda/Ev and shareholder yield receive a high rank when the number is high? How can I devide Ebitda through EV? thanks for the former advice that helps!

  5. Okay, so I created a path how to do it on portfolio123 maybe it is interesting for members, however there are some mistakes, maybe you can help me 🙂

    – Get a free trial

    – go on tools -> Ranking -> Systems
    -Create: New Stock Ranking
    -Go on Stock factor node
    – Fundamentals: Ratios: Per Share Ratios:
    – Choose: Earnings per share (suggested ranking: Higher Value); Book Value Per Share (suggested ranking: Higher Value); Sales per Share (suggested ranking: Higher Value) Free Cahs Flow per Share (suggested ranking: Higher Value),

    Add node: Stock Formula: ” EBITDPSTTM / EVPS” (Here is an error, when applied to the screening it says:error near divided : Invalid command “divided ??
    Then shareholder yield; i did not find buyback
    Then safe the ranking (ranking name)

    Then go on screener: Screens: New Stock screen
    Ranking -> other rank -> choose (ranking name)
    Long rule: rating(“ranking name” > 90

    then sort by 6 month % change (price appreciation) and choose the 25 best stocks

  6. okay, so I continued to try out and I would be glad if you would tell me whether the rules I used in portfolio were right 🙂

    1. Ranking the formulas:

    negative ranking


    positive ranking:

    100*(1-Shares(0,QTR)/Shares(4,QTR)) + Yield (here I am not shure, maybe you have a better formula?)

    Screen Rules:
    MktCap > 50000
    Rating(“V2”) > 90

    sort by 6 month appreciation

    buy the best stocks according to 6 month appreciation:

    Statoil ASA
    China Petroleum & Chemical Corp Sinopec
    Statoil ASA
    China Petroleum & Chemical Corp Sinopec
    Nippon Telegraph & Telephone Corp Ntt
    Wal-Mart Stores Inc
    Gazprom PJSC
    Petrochina Co Ltd
    JPMorgan Chase & Co
    Ford Motor Co
    Wells Fargo & Co
    American International Group Inc
    Allianz SE
    Citigroup Inc
    Toyota Motor Corp
    BNP Paribas
    Bank of America Corp
    Daimler AG
    Mitsubishi UFJ Financial Group

  7. Sorry it took so long to reply. I was out of town.

    Here's a ranking system for VC2. You can save it under your own profile and modify it as you see fit. It has a different formula for shareholder yield but the one you posted should also work (looks like you're using the forum!):

    Market cap should be > 223, which is $223 million ($200 million adjusted for inflation to 2016 dollars (he used 2008 $ in the book)).

    The top five stocks by 6 month % change as of July 5th are: TLN, WILN, CZZ, CECO, CACQ.

    Hope this helps!

  8. hey, thanks for the hint! Yes, I searched in the forum. However I cannot use the link, because I am only trial member 🙁
    could you post a scrrenshot? With my screen I got CZZ however the other one enterprises not

  9. yes, now it works 🙂 thank you!

    the ranking system is called “V5”
    (the fifth trial :D)

  10. but you really need trust in the strategy, at the moment most of the titles are mining, gas and fuel and many of them are labelled as high risk investments from (it is a German site) what do you think about that?

  11. but I also get the point, that the strategy has be statistically shown to be working. On the other hand, statistics are unsensitiv to qualitive arguments and maybe investing too much into mining (because they crumbled last years and now are all going up) contradicts the rule to diversify. I am interested to what you say about this point.

  12. Yes, there a lot of energy stocks in the strategy right now. They're recovering and have good value. Like you said and I've posted about, the strategy has worked in the past, and it has also worked out of sample (2010-2016).

    Additionally, you shouldn't employ just one strategy. Look into the consumer staples value strategy I posted about too. This will diversify your holdings and help a lot psychologically. What will also help is using stop losses (dump a stock if it decreases too much in price). You can backtest things like that on P123.

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