- Joel Greenblatt is the greatest post-Buffett teacher of investors.
- His words deserve to be given a great deal of attention.
- His Fall 2012 interview with the Graham and Doddsville newsletter yields many profitable insights.
There must be something special about Joel Greenblatt. Other than Buffett and Ben Graham, no investor seems to be given more credit for influencing other successful investors. The strangely titled You Can Be A Stock Market Genius has probably been read by 90%+ of hedge fund managers, and I know of no other book which is cited more by successful investors, other than Security Analysis.
Still, Greenblatt may not be given enough credit in the long shadow cast by Warren Buffett. He does, however, makes things sound simple, just like Buffett.
The purpose of this article is to examine a 10-page interview with Greenblatt that appeared in the Fall 2012 issue of the Graham and Doddsville Newsletter in the hopes that this will inspire all readers to more diligently apply the common sense principles Greenblatt elucidates. I read it recently and found it to be quite valuable, and so wanted to bring some of what I took from it to Seeking Alpha in condensed form.
The title of the interview is: "Thought Process and Clarity are Key."
Greenblatt's Formative Independent Reading
Greenblatt's conversion into the investor he is today began as a junior at Wharton, when he read an article about Ben Graham in Forbes Magazine. This was probably about 1978 or 1979. He must have been pre-disposed to a career in business (and going for the big bucks) because he was attending Wharton and reading Forbes at the age of 20.
Here is what he told the interviewer about that initial encounter with Graham:
The article outlined how he had this formula to beat the market... I read that article and a light bulb went off - I thought: "boy, this finally makes some sense to me."
A light bulb went off! That has been many people's experience when they first read Ben Graham.
I started reading everything I could by Benjamin Graham. I also read a book called Psychology and the Stock Market by David Dreman. He was one of the first people to focus on behavioral finance and was really ahead of his time. I started reading about Buffett and his letters.
Greenblatt goes on to describe himself as self-taught regarding the stock market. His independent reading is what really taught him the skills that he later put to use in becoming a millionaire, although he acknowledges that he learned how to "tear apart" financial statements through school and his family, which was involved in business. This should give hope to anyone with an interest in stocks, who doesn't necessarily have a finance-related education. He says:
… my understanding of the stock market really came from my own independent reading.
It is clear that Greenblatt became very excited when he encountered Graham's claim to have a formulaic way to beat the market, and this "formula"-thing has been a theme throughout Greenblatt's writing and investing career. (See: The Little Book That Still Beats the Market.) He really wanted a formula.
Desire to Educate
Greenblatt goes on to explain his desire to write his first book, You Can Be a Stock Market Genius, by the fact that he himself had learned the fundamentals of what he was doing through reading other investors' books. I guess he wanted to contribute to that lineage of investing wisdom (as he certainly has).
Funnily enough, he thinks he missed his own mark with You Can Be a Stock Market Genius, because it was a little too complicated for the type of amateur he was really trying to educate. Instead, it became a favorite with the more sophisticated set, including hedge fund managers.
It appears that Greenblatt does not have an endless hunger for money. His firm Gotham Capital managed outside money for ten years from 1984 to 1994, and then returned the outside capital, staying open only to invest the insiders' capital. He strikes me as someone who wanted to make a significant amount of money to take care of all he could ever want, most likely, but then to pursue other things, such as his teaching position at Columbia University and his involvement in Charter School charities in New York City. I'm sure he had investors clamoring to pay him big bucks to manage their money in 1994, but I guess he knew he had enough at that point.
On You Can Be a Stock Market Genius:
I wanted to write it in a friendly, accessible way so that individual investors could profit from it as I had.
… I ended up writing a book that most hedge fund managers have read, but one which was perhaps at a little higher level than I had intended.
I am very proud of that book, but I just think it's written at such a level that you have to be fairly sophisticated in financial analysis, at least, to fully profit from its advice.
When "Graham and Doddsville" asked him if the same special situations opportunities exist today that he was writing about in You Can Be a Stock Market Genius, Greenblatt replied that yes, he thinks they do:
What happens to people who become very good at special situation investing is that they make a lot of money, and then they get a little too big to invest in some of the smaller situations that are out there.
I think in [You Can Be A Stock Market Genius] I said something to the effect of: "don't worry about getting too big for these strategies until you get to about $250 million. When you get there, give me a ring." I would bump that number up to over $1 billion today.
Then Greenblatt makes this definitive statement:
There are still many strategies in that book that could make you a lot of money.
He has no real motive to overly tout his own book. I think you can rely on what he says.
Then Greenblatt starts to get into the "time arbitrage" that investors can take advantage of in our increasingly institutionalized investing world:
One argument I make in another one of my books (which few have read), called The Big Secret for the Small Investor, is that the world has become much more institutionalized over the years, even more than it was when I wrote You Can Be a Stock Market Genius, and that is a real advantage for longer-term investors... If you're an active manager, you may have a long-term horizon but your clients probably don't. So, most managers feel that they need to make money over the short term. Therefore, professionals systematically avoid companies that are perhaps not going to do as well in the short term.
Despite the fact that most, if not all, big money managers are aware that spin-offs are a profitable way to beat the market, that valuation gap has still not closed. Spin-offs that are too small for institutional managers to invest in present an even more compelling investment opportunity (and this is something I personally plan to look into as a result of reading the interview).
Greenblatt is not concerned that the sophistication of modern markets has lessened opportunities. He sees systemic causes of profitable opportunities.
Nowadays Greenblatt invests much more formulaically than he used to. He used to hold an amount of stocks in the single digits. Now, if you look at Gotham Capital's 13-F disclosures, it seems like he owns a tiny bit of every stock on the market.
He told an interesting story about being tempted to do a little human tweaking of his formula's recommendation:
There's a certain medication on the market that's made by a small pharmaceutical company. This company was considered a very attractive buy according to one of our screens. But I knew why it looked cheap - its key medication was coming off of patent the next year and the stock was priced accordingly. My inclination could have possibly been to override the formulaic recommendation because I knew exactly what was going on. It wasn't like it was a big secret. I didn't override anything, however, and the company subsequently figured out a way to extend the patent a little longer which then led to a doubling of the stock price over the next six months.
And maybe my favorite quote from the whole interview:
One thing I would say is that a common characteristic of many of the stocks that we buy is that everyone hates them.
Investing can certainly be scary.
The Value of Limiting Downside
One of the most enlightening points Greenblatt makes in the whole interview is in his discussion about downside/upside.
One of the things I said in You Can Be a Stock Market Genius is if you don't lose money, most of the alternatives are good. Even if you don't know what the upside is - if you just know there's upside - you can create scenarios where you have an excellent risk/reward. Positions with limited downside are the types of positions that I have loaded up on in the past.
This was actually the exact thinking with which I bought into cheap, safe Bank of Utica (OTCPK:BKUTK). I don't know if there is much upside, but I feel quite protected from a downside because of how conservatively the bank is run (probably too conservatively). I figured I won't lose money, I'll get a dividend, and maybe it will appreciate to a price more in line with its peers.
A floor underneath you is worth a shorter ceiling.
Mr. Market Eventually Treats You Right
Greenblatt goes on to confirm that one tenet of faith in value investing, that "if you're good at valuing businesses, the market will eventually agree with you." Eventually. It may take a couple years but it will happen.
This was the spirit in which I took a position in Alloy Steel International (OTCPK:AYSI). The stock is so insanely cheap that a sane investor must question what he's seeing when he compares the financial results to the market price. I wrote up my findings in a recent article.
A Keen Valuer Doesn't Need a Ton of Positions
Greenblatt tells the interviewer that for much of his career, six or eight stocks represented 80%+ of his portfolio. Most, but certainly not all, value investors tend to own less rather than more stocks. Diversification will absolutely dilute your best ideas - if those ideas are truly good.
On the Value of Experience
As you gain experience you start to understand risk/reward; you start understanding what looks like a good opportunity and what doesn't; you recognize when you have more knowledge than the market about a given issue and when you don't.
Who Can Do This?
Warren Buffett has said that rationality is the most useful attribute in investing. Greenblatt gives a similar description towards the end of this excellent interview, when talking about finding other exceptional investors:
I... look at thought process… you want to find people who think correctly… Those who think clearly, stand out… There is a certain thought process and clarity of thought that those who are great at [investment analysis] have.
(As an aside, this description immediately makes me think of Nate Tobik, who writes the Oddball Stocks Newsletter. He is very smart, very rational, and a great model for anyone looking for bargains in the less followed areas of the market.)
Why Joel Greenblatt is Important
Joel Greenblatt is worth paying attention to. His Gotham Capital is reported to have achieved 40-50% returns annually over its lifetime and he has the respect of many of the present day's most successful money managers. He clearly has a gift not just for investing, but for teaching people how to be great investors. He is surely on the shortest of short lists of required reading for anyone who wants to try their hand at stock picking.
Disclosure: I am long BKUTK, AYSI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.