## Quantitative Approach to Investing (Multi-factor Model Approach)

#### GLOSSARY

Anomaly (plural - anomalies):  An anomaly is an exception to the rule, a deviation from what is expected.  In this case, the rule is the Efficient Market Hypothesis (EMH), so an anomaly is any information that doesn't agree with the EMH.  Since the EMH says that no information can be used to help you to earn an above average rate of return, an anomaly is any information that does lead to consistent above average performance.

The quantitative approach first identifies any market anomalies which can be placed into a model.  (Anomalies are characteristics of stocks which have been associated with above average rates of return in the past.)  Regression analysis is often used to identify the power of the anomalies, or those which would lead to the highest return.  These anomalies (or factors) are then placed into an equation which weights each of the factors.  The equation is then used to rate stocks as to their attractiveness.  An example of a multi-factor equation would be:

Rating factor = a + b1(E/P) + b2(D/P) + b3(Earnings

where:

 a = a constant number derived from a regression analysis b1, b2, & b3 = regression coefficients (numbers) which show the strength of the anomaly E/P = the earnings/price ratio (the reciprocal of the P/E ratio) D/P = the dividend yield of the stock Earnings Surprise = the actual earnings divided by the consensus forecasted earnings for the most recent quarter.