Tuesday, May 3, 2011

Book Review: Value Investing: Tools and Techniques for Intelligent Investment, by James Montier

Value Investing: Tools and Techniques for Intelligent Investment is at its heart a gathering of James Montier's recent online writings. For his online followers, most of the material here has been touched upon and is, for the most part, reprinted here with little modification. However there a number of new additions, most notably on the recent financial crisis. Mr. Montier, of British origin and previously from Société Générale, now plies his trade at GMO, a value investment firm with a quantitative orientation. Perhaps not surprisingly, Value Investing is a book heavy on stats and graphs from various experiments and research. Apart from those graphs demonstrating value investing results and the pitfalls of investing in general, the most interesting of the research cited in the book chronicle various human weaknesses, often at first seeming unrelated to finance, and how they contribute to our lower performance on the stock market. These include, among others, overconfidence, obsession with excessive information, and tendency to extrapolate recent trends into the future. Generally speaking, not surprisingly given that he authored three other books on the topic (Behavioural Investing: A Practitioners Guide to Applying Behavioural Finance
, The Little Book of Behavioral Investing: How not to be your own worst enemy
and Behavioural Finance: Insights into Irrational Minds and Markets
), Mr. Montier believes, and I tend to agree, that most of our investment failings are due to psychological factors.

Not that actual investment methods are faultless in all of this. Mr. Montier takes an axe to today's investment teachings revolving around the Efficient Market Hyphothesis and most of its assumptions. The first part of the book explores EMH's implications, logical incoherence and empirical results. Amongst other things, for instance, low beta stocks are shown to outperform high beta stocks, which is the exact opposite of theory. Mr. Montier also explores the shortcomings of Discounted Cash Flow models and the inability of analysts' to forecast, and others.

A few alternatives are offered throughout the book, such as the use of the "Graham-and-Dodd PE", the Piotroski score, using reverse-engineered DCF to analyze the implied assumptions behind current prices, guarding against business and financial risks, etc. In what is probably the most interesting part of the book, Mr. Montier proposes some tests to identify short candidates. While I myself have no interest in shorting, it does give a suggestion on stocks to avoid. In all most if not all cases, these involved quantitative measures. While these don't occupy the majority of the book, which clocks in at well over 300 pages, Mr. Montier goes well enough in the detail of their reasoning and results for the book to merit the "Tools and Techniques" part of the title.

The text isn't without flaws. One thing that might grate some readers is how vitriolic Mr. Montier is in pointing the weaknesses of current investment theory and practices. Not that his points aren't valid, quite the contrary, but it's hard not to get distracted by his sometimes acidic tone. Another criticism is that, while there are plenty of quantitative tools suggested, this book doesn't give any clue whatsoever how to approach the qualitative features of stocks. That said, some value investors are far more, if not exclusively, concerned with the numbers in the financial statements as opposed to doing a business analysis, and most analysis can probably be quantified, but the omission of this topic is noticeable and a huge disappointment. Perhaps the biggest criticism one can address to this book is the format. As mentioned previously, most of Value Investing consists of reprinted material from Mr Montier's online postings over the past few years, with some updates. Readers and non-readers of his blog would probably feel offended at paying for something that is free online. But I think this is a moot point. Rehashed ot not, there's is far too much material to make revisiting Mr. Montier's online postings an easy task. If anything, having them all regrouped in one tome makes far more convenient to revisit them (for my part, I've read the book 2 times from start to finish so far, while revisiting specific sections numerous other times). That said, the format does make the text disjointed. Perhaps more time should've been spent rewriting and editing the postings so they fit each other more, rather than making it seem like an obvious copy and paste job.

Nonetheless, Mr Montier's Value Investing is certainly a highly practical book and very actionable. The most important thing to take away from this book, and a recurring theme in all of Mr. Montier's writings, is that investing is more psychological than anything else. Entertaining and with interesting implications, I highly recommend this book. I plan to come with a review of Mr. Montier's follow up, the Little Book of Behavioral Investing, some time soon.