The Little Book that Beats the Market: Chapters 12 & 13

Joel Greenblatt, the book's author, is a value investor extraordinaire and a professor at Columbia's business school. In the book, Greenblatt discusses and justifies the "Magic Formula", a stock selection method that allows individual investors to beat the market using value investing.

Chapter 12: Choosing a broker/fund manager

In this chapter, Greenblatt warns about the pitfalls of following some of the other investment options that are available to individual investors.

First off, individuals may get direct stock advice from stockbrokers. While stockbrokers can help explain some elements of investing and probably do want you to succeed in the long term, investors must keep in mind that brokers make their money by selling something to the investor, not by the long term success of the investor.

Rather than relying on a broker, mutual funds or hedge funds offer a better alternative, because they are motivated by track record to a larger extent. Nevertheless, these funds make more money by becoming larger and larger (so they can charge fees for the size of the assets under management), which makes it more and more difficult to maintain strong levels of performance. Furthermore, after fees, most of these funds are bested by the market.

While there are good managers out there that can beat the market, there are many more who will not. Just as the magic formula can lose to the market in three-year periods, so too can good money managers. In the same way, poor managers can beat the markets over periods of such length. As such, it very difficult to identify a fund manager with whom one should invest.

Investing in index funds is therefore an option which allows investors to closely match the market's return. But that's all the investor can do with such funds: Match the market. To beat the market, investor's should use the magic formula.

Chapter 13: Education

While he cannot guarantee the results of the magic formula going forward, Greenblatt does believe that using it over the long-term will provide investors with excellent returns. But despite the money that can be accrued following this technique, Greenblatt doesn't believe this type of investing adds any value to society.

While the stock market does provide a valuable service, creating a secondary market that allows the primary market to raise capital for companies that need it to grow, Greenblatt believes that 95% of the trades out there are completely unnecessary to serve this purpose. For this reason, Greenblatt makes the case that investors who profit from this formula should use some of those profits for purposes that do benefit society.

In particular, Greenblatt argues that the education system needs help. Education is the foundation for the high-level work force that helps the economy thrive. But much potential is wasted. In every major U.S. city, only half of public school ninth graders end up graduating from high school.

In a capitalist system, capital moves from poor businesses to productive businesses, and that's what helps the economy thrive. In the school system, however, it is very difficult to close poorly performing schools and stop paying teachers that can't get the job done, in order to divert capital to better performing schools/teachers. Greenblatt argues that this issue needs to be addressed, and provides the reader with some means to do so.

Comments

[User 458324:]

I TAKE IT YOUR ONE OF THE POORLY EDUCATED, BECAUSE YOU CAN'T TELL THE DIFFERENCE BETWEEN 11, 12 AND 12,13

Nov 02 01:48 AM

[SA Editor J...:]

The mistake was ours, not the author's. Thank you for bringing it to our attention.

Nov 02 08:37 AM