Thoughts on Quantitative Screens

"Many shall be restored that are now fallen and many shall fall that are now in honor." Horace

Toward the end of his life, Benjamin Graham, the genius who essentially founded the field of security analysis with his book of the same name decided that much of security analysis was pointless. In the 1970s, he had been studying the returns of stocks bought with low P/E ratios in conjunction with low Debt/Equity ratios and found that it would be quite simple for the know-nothing investor to outperform the market using such blind stockpicking.

Much has been written about such "quantitiative" or "mechanical" investing, especially since the publication of Joel Greenblatt's Magic Formula, which in essence ranks stocks by return on capital (ROC) and EV/EBIT (enterprise value/earnings before interest and taxes). Others who have followed in this vein include Tobias Carlisle (Quantitative Value, Deep Value) and James O'Shaughnessey (What Works on Wall Street). The latter two authors have most recently endorsed the use of EV/EBITDA, or the acquirer's multiple, as the single best value criterion for buying stocks.

In fact, Carlisle suggested that the addition of ROC to the Greenblatt formula has reduced the returns of the Magic Formula due to reversion of the mean; that is companies which now exhibit high ROC are more likely to return to normal.

Greenblatt himself found that most people who used the Magic Formula still underperformed! The reason? They were tweaking the formula. It is so emotionally difficult to hold stocks which are clearly "value traps" (for instance, for-profit education stocks). But perhaps in stocks with such an obvious "ick" factor is where the gains lie.

(and for what it's worth, by this  time, he had also been turning his attention to many of his other pursuits like classic literature, but that is besides the point).

I think Nate Tobik has done a wonderful job synthesizing some of the pros and cons of quantitative investing here: http://www.oddballstocks.com/2013/01/thoughts-on-quantitative-value-investing.html

What are your thoughts?