The Economics of Security Analysis Kewei Hou∗ Haitao Mo† Chen Xue‡ Lu Zhang§ Ohio State and CAFR LSU U. of Cincinnati Ohio State and NBER July 2021¶ Abstract The investment theory, in which expected returns vary cross-sectionally with invest- ment, profitability, and expected growth, provides an economic foundation for Graham and Dodd (1934). The q5 model is a good start to explaining prominent quantitative security analysis strategies, such as Abarbanell and Bushee’s (1998) fundamental sig- nals, Frankel and Lee’s (1998) intrinsic-to-market, Greenblatt’s (2005) “magic formula,” Asness, Frazzini, and Pedersen’s (2019) quality-minus-junk, Bartram and Grinblatt’s (2018) agnostic analysis, Ball, Gerakos, Linnainmaa, and Nikolaev’s (2020) retained earnings-to-market, and Penman and Zhu’s (2014, 2020) expected-return strategy, as well as top-notch active, discretionary funds, such as Buffett’s Berkshire Hathaway. ∗Fisher College of Business, The Ohio State University, 820 Fisher Hall, 2100 Neil Avenue, Columbus OH 43210; and China Academy of Financial Research (CAFR). Tel: (614) 292-0552. E-mail:
[email protected]. †E. J. Ourso College of Business, Louisiana State University, 2931 Business Education Complex, Baton Rouge, LA 70803. Tel: (225) 578-0648. E-mail:
[email protected]. ‡Lindner College of Business, University of Cincinnati, 2338 Lindner Hall, 2906 Woodside Drive, Cincinnati, OH 45221. Tel: (513) 556-7078. E-mail:
[email protected]. §Fisher College of Business, The Ohio State University, 760A Fisher Hall, 2100 Neil Avenue, Columbus OH