[MUSIC PLAYING]
SPEAKER: Joel Greenblatt, our guest for today,
is the co-founder, managing principal,
and co-CIO of Gotham Asset Management.
We could not be more thrilled and more grateful
than to have him accept our invitation and be here.
Thank you so much, Joel-- over to you.
[APPLAUSE]
JOEL GREENBLATT: Thanks so much.
Thanks for coming out today.
I really appreciate it very much.
I've never been here before, so I'm looking forward to my tour
right after, so thank you.
So even Warren Buffett says the vast majority of people
should index, and I agree with him.
So are there any questions, or do I have any time?
[LAUGHTER]
Then again-- well, I have time, so then again, Warren Buffett
doesn't index and neither do I. So I thought I'd tell you why,
and then maybe you'll have some more information
to decide for yourself what makes sense for you.
And in a sense, it shouldn't be that hard.
Actually, I had a friend who's an orthopedic surgeon
and is in charge of a group of orthopedic surgeons.
And he asked me to speak to them at a dinner,
about the stock market.
And I said, OK, these are smart, educated guys.
They can understand this stuff.
And I spoke for about 35 minutes,
explaining how the stock market worked and everything else.
And then I started getting questions along the lines of,
oil went down $2 yesterday--
What should I do?
Or a market was up 2% yesterday--
what do I do about that?
So my interpretation of those questions
was I had just crashed and burned.
So last year, I was lucky enough to be
asked to teach a ninth-grade class, a bunch of kids,
mostly from Harlem.
And I had just sort of crashed and
burned with the orthopedic surgeons,
and I didn't want to do that with the kids.
And so I started to try to think of,
what could I do to explain the stock
market a little bit better?
And so I walked into class the first day,
and I handed out a bunch of three-by-five cards.
And I brought in this jar of jellybeans right here,
and I asked--
the students passed around the jar of jellybeans.
I asked them to count the rows, do whatever they wanted to do,
and write down their best guess for how many jellybeans
were in the jar.
I collected the three-by-five cards,
then I went around the room, one by one,
to each one of the kids in the room.
And I said, listen, you can keep your guess
or you can change your guess.
That's up to you.
And I went, one by one, around the room
and asked people how many, and wrote down the various guesses.
So it turned out, the average of the guesses
for the three-by-five cards was 1,771 jellybeans.
There are 1,776 jellybeans in the jar,
so that was pretty good.
The guess when I went around the room, that was 850 jellybeans.
And I explained to them that the stock market's actually
second-guessed, because everyone knows what they just
read in the paper or what the guy next to them said,
what they saw in the news, and are influenced
by everything around them.
And that was the second guess, and that's the stock market.
The cold, calculating guess, when
they were counting rows and trying
to figure out what was going on, that
actually was the better guess--
that's not the stock market.
But that's where I see our opportunity.
Once a year in my class at Columbia, at least
for the last five, six years, somebody raises their hand
and asks a question that goes something like this--
hey, Joel, congratulations.
You've been doing this for 35 years,
and you've had a nice record.
But now there are more computers, there's more data,
there's more ability to crunch numbers.
And isn't the party over for us?
Isn't it just more hedge funds?
It's just a lot more competition.
Isn't the party over for us?
So my students are generally second-year MBAs--
I'd say average age, 27 or so.
So I just answer it this way.
I tell them, let's go back to when you learned how to read.
Let's take a look at the most followed market in the world.
That would be the United States.
Let's take a look at the most followed stocks
within the most followed market in the world.
Those would be the S&P 500 stocks.
Let's take a look at what's happened
since you learned how to read.
So I tell them, from 1997--
when they were 9 or 10--
to 2000, the S&P 500 doubled.
From 2000 to 2002, it halved.
From 2002 to 2007, it doubled.
From 2007 to 2009, it halved.
And from 2009 to today, it's roughly tripled,
which is my way of telling them that people are still crazy.
That was just the last 17 years.
And I'm way understating the case,
because the S&P 500 is an average of 500 stocks.
If you lift up the covers and look underneath what's
going on, there's huge dispersion
of those 500 stocks between those,
at any particular time, that are in favor and those
that are out of favor.
And so there's a wild ride going on underneath the covers.
If you look under the covers, there's
a wild ride of those 500 stocks at any particular time.
And that doubling and halving, doubling
and halving with the average of 500 stocks
is really smoothing the ride.
So there should be an opportunity.
And if you understand what stocks are--
and I guarantee my students, first day of class--
I make a guarantee every year.
And they walk in, and I guarantee them
this-- if they do good valuation work of a company,
I guarantee them the market will agree with them.
I just never tell them when.
It could be a couple weeks.
It could be two or three years.
But if they do good valuation work,
the market will agree with them.
Stocks are not pieces of paper that bounce up and down,
and you put complicated ratios on,
like Sharpe ratios or Sortino ratios.
Stocks are ownership shares of businesses
that you are valuing and, if so inclined,
tried to buy at a discount.
So if you believe what Ben Graham said,
that this horizontal line is fair value,
and this wavy line around that horizontal line
are stock prices, and you have a disciplined process
to buy, perhaps, more than your fair share when they're
below the line, and, if so inclined, sell
or short more than your fair share
when they're above the line, the market
is throwing us pitches all of the time.
The reason people don't outperform the market--
there are behavioral problem.
There are agency problems.
But it's not because we're not getting those opportunities.
I will show you briefly--
let me tell you how we value stocks.
It's not very tough, and I think most of you will understand it.
And I think the best example that
seems to resonate with most people
is thinking about buying a house.
And to keep the numbers simple, let's
say that someone is asking $1 million for the house.
They want to sell, and your job is
to figure out whether that's a good deal or not.
So there's certain questions you would ask.
One of the first questions I'd ask
is, well, how much rent could I get for that thing, OK?
So in other words, if I rented out that million-dollar house,
how much rent would I collect?
If I were going to collect $70,000, $80,000,
$90,000 a year--
7%, 8%, 9% yield on that house--
that's one way I might go about valuing it.
And what's the next question you would ask?
I'm pretty sure I know what it would be.
What are the other houses on the block going for,
on the block next door and the town next door?
How does this compare?
How relatively cheap is this, relative to all
my current choices?
So that's what we do.
We look at, how relatively cheap is
this business, relative to other similar businesses,
relative to a whole universe of choices that I have?
We do that.
We also go back in history, look at how
this company or this house has traditionally
been valued, versus other ones in the neighborhood
or versus other communities.
And how is it being valued now?
So measures of absolute and relative value--
absolutely cheap on a rental basis,
relatively cheap on all different kinds of measures
that make sense to you--
now, you wouldn't use any of these measures
all by themselves.
If you just used relative cheapness-- if some of you
remember the internet bubble, and you
bought the cheapest internet stock, that wasn't cheap.
It was just cheap relative to all
the other crazy-priced stocks at the time.
But we use our measures of absolute and relative value
as checks and balances against each other
to try to zero in on fair value.
So when you do this--
I just want to show you a simple chart.
This is actually a study we did of our valuation methodology,
very similar to the way I just said we value a house.
This is how we-- we looked at the 2,000 largest
companies in the US over a 20-year period.
This was 1992 to 2012, and we ranked them on a daily basis
from 1 to 2,000, based on their discount
to our assessment of value, using these metrics.
The x-axis here-- you probably can't see it--
is just a valuation percentile.
All this means is if you were in the bottom left-hand corner,
and you were in the first percentile,
you're the 20 companies at any particular time,
out of those 2,000, that measure cheapest,
according to our measures of absolute and relative value.
Go to the 99th percentile--
you would be the 20 companies that measure most expensive
out of those 2,000.
The y-axis is the year forward return on average
during those 20 years.
What this chart simply says is, on average,
stocks that fell in our first percentile, the cheapest 20,
averaged a one-year forward return during those
20 years of 38%.
Stocks that ranked in our second percentile
averaged a one-year forward return of about 37%.
And then we drop down to this best-fit line, which we always
say we don't mind missing when we're making extra money.
And then as we measure something more expensive,
the year forward return drops.
And if you were sitting in my class at Columbia and I said,
hey, does anyone see a long-short strategy
you might pursue if you could predict ahead
of time which stocks would do best, second best, third
best, in order, and you did not say,
I guess I'd buy these guys up here
in the upper left-hand corner and short
these guys in the bottom right-hand corner--
if you didn't say that, I'd probably throw you out
of class, because it's very straightforward.
That's what you should do.
And by the way, that's what we do.
The important thing to understand
is that stocks are ownership shares of businesses, OK?
Now, by the way, that beautiful chart
I showed you with the 90% fit--
why doesn't everyone do this?
Well, unfortunately, it doesn't look
like that when you're living through that.
That's an average over 20 years.
If I showed you a snippet of three or four years,
the fit would be nice.
It might be 0.55, 0.6, something like that.
But it's not going to be very cooperative, right?
If what we did worked every day, and every month,
and every year, everyone would do it.
It would stop working--
but it doesn't, unfortunately.
But the reason that we stick to what we're doing even
when it's not working is that chart,
meaning the way we value companies,
our measures of absolute and relative value,
are approximately how the market values them over time.
If we were, for instance, momentum investors--
OK, and I will tell you that for those of you
who know that means, momentum has
been studied across the globe over the last 30, 40
years in the US.
It's worked pretty much everywhere--
not all the time, but on average it's worked very well over 30,
40 years, and not just in this country.
But here's the problem.
What if it didn't work over the next two or three years?
It could be that we just have to be patient.
It works over time, and it's cyclical.
And so it's out of favor, and we just have to stick to our guns
because it's something that's worked.
Or it could be, if it didn't work in the next two or three
years, that the explanation is, hey,
it's not so hard to figure out.
A stock used to be down here, and now it's
up here-- it's got good momentum.
And with all the data, and the ability to crunch numbers,
and computers, and studies that have come out,
it's a crowded trade.
It's degraded.
It's not as good as it used to be.
And if that's what happened over the next two, three years,
I would know the answer to that question.
I didn't know which one it was.
Should I just be patient, or has the trade degraded?
But if you view stocks as ownership shares of businesses
that you value and try to buy at a discount,
and that doesn't work for a couple of years,
I'm not going to change what I'm doing.
I'm not going to buy the bottom right-hand corner,
buy all the money-losers and the companies
that don't earn anything or are trading it
100 times, free cash flow.
I'm not going to buy those, even if it works
in one particular year, and then sell the ones that are cheap,
relative to everything, get me high rents,
and everything else.
I'm not going to change my strategy,
and I believe that stocks will eventually-- not
right now, but eventually people get it right.
And I may have to be patient.
That's really what I have to do.
What that chart tells me is I'm on the right track,
meaning that's sort of our true north,
and we just have to be patient to get there.
The reason that these simple metrics don't get arbitraged
away is-- the example I usually use for arbitrage is, oh, you
see gold in New York at $1,200, and it's selling at London
simultaneously at $1,201.
Well, an arbitrageur sitting on a trading desk someplace
will see that and buy up gold in New York at $1,200
and push the price up a little bit.
He'll simultaneously sell gold in London at $1,201,
push the price down.
And they'll converge somewhere in the middle,
and it'll happen so fast on a trading desk
that you don't really even get to see that.
But what if I told you, you could buy gold in New York
today at $1,200, and sometime in the next two, three years
you're going to make money, but you
could lose 20% of your money while you're waiting?
There's no guy sitting on a desk anywhere that
really can do that.
And frankly, time horizons are getting shorter.
It used to be, when I was younger,
I used to get quarterly statements,
and most people would throw them in the garbage.
Now you can check your stock price 30 times a minute
on the internet.
Maybe some of you do.
And time horizons are shrinking, and we're just
playing time arbitrage.
We're being patient, buying cheap, good businesses,
and waiting for the market to recognize the value we see.
But it takes some work to value companies.
And let's say you don't want to do that.
You have a day job.
I guess everyone here has a day job,
so you don't want to do that.
So one thing you could do is try to find someone
good to do it for you, right?
I'm showing you there's this opportunity.
Maybe someone can do it for you.
And what you should probably look
for when you're looking for that person
is someone who has a good investment process that
makes sense to you.
The problem is, for most active managers,
if you think of their challenge--
when they're picking an individual stock,
they must think that they have a variant hypothesis as to why
that stock is priced differently than the way it should be.
And I can tell you, I've been doing this over 35 years,
and it's very rare.
Almost never have I bottom-ticked a stock, bought
it at the absolute bottom.
So 99.9-plus percent of the time,
a stock is down after I've bought it.
And there are really only two reasons why--
one is I was wrong.
The other is I just need more time
for my thesis to play out, OK?
Now, as an outside allocator, you
don't really know what the thesis for the individual stock
was.
Even the manager himself sometimes doesn't know.
When things are going against you,
there are all kinds of agency problems.
You've got people to answer to.
You have behavioral issues, just naturally-- you
start to doubt yourself.
It's very unclear sometimes, even to them,
what their biases are and what they're doing.
They did studies that you guys are familiar with, probably,
of why the home team always wins in sports,
or at least wins more than it should.
And the original thesis was generally, oh, they're
used to the court.
They slept in their own bed.
The fans, they jazz them up, whatever it might be.
And when they controlled for all these variables,
the answer turned out to be that the refs don't
like to get booed, OK?
So they don't think that they're being biased.
I'm sure in 99.9% of cases, they don't, but they
don't like to get booed.
And so they're being influenced by--
and so there's the same problem with an active manager.
He's got agency behavioral issues that he's not sure of.
So the allocator doesn't really understand the thesis
behind each pick.
It's not clear that the manager is totally unbiased
when he has a variant thesis that's going against him.
And so since you don't know the thesis
as an allocator, most people--
all they have are the returns, and that's what they used.
So in an interesting study that came out
the day after Thanksgiving--
so it was interesting to me, probably not interesting
to the guys who did the study.
Morningstar put out a study of their star system.
And their star system is based on past returns,
letting you know who's done the best over the last one, three,
and five years.
Of course, my interpretation of their study
was that our star system doesn't work.
We can't discern.
The last one, three, five years of returns
has not much to do with the next one, three, five.
But that's what everyone uses.
I wrote a book.
I hold it up here.
It's called "The Big Secret," and I always
say it's still a big secret because no one read it.
[LAUGHTER]
And in that book, I talked about a few studies.
Number one, it talked about the best-performing manager.
I wrote it in 2011, so it talked about the decade
2000 to 2010-- looked at the best-performing mutual fund,
a study of the best-performing mutual fund for that decade.
That fund was up 18% per year, 100% long in the US equities.
The market was flat during those 10 years,
so 18% up a year is pretty good.
Unfortunately, the average investor in that fund,
on a dollar-weighted basis, managed to lose 11%
a year because every time the market went up,
people piled in.
When the market went down, they piled out.
When the fund outperformed, they piled in.
When the fund underperformed, they piled out.
And they took an 18% annual gain and turned it into an 11%
annual dollar-weighted loss--
why?
Well, to beat the market, if you're beating by 18 points,
you're doing something different than the market.
You're going to zig and zag differently.
You can't do the same as the market.
You have to do something different.
You're going to zig and zag differently.
Institutional managers are no different.
Here are the stats on the-- if you just took a look at the top
institutional managers for that decade, the ones who--
2000 to 2010-- the top-quartile managers,
the ones who ended up with the best 10-year record,
here are the stats on them.
97% of those who ended up with the best 10-year record,
top quartile, spent at least 3 of the 10
years in the bottom half of performance--
not shocking, but everyone, right?
To beat the market, you have to do something different.
You're going to zig and zag differently.
79% of those who ended up with the best 10-year record
spent at least 3 of the 10 years in the bottom quartile
performance.
And here's the stunner--
47%, roughly half of those who-- they ended up with the best
record, but they spent at least 3 of those 10 years
in the bottom decile, the bottom 10% of performers.
So you know no one stayed with them,
but they ended up with the best record.
So it's very hard to pick an allocator,
because you don't know the thesis,
so you're using past returns.
But when you do that, all you're doing
is chasing your tail, going in and out at all the wrong times,
So it's very hard.
What a good allocator--
usually an institutional allocator, and there
are a few of them--
should be looking at process, and do you
stay with your process.
But of course, there's agency problems
on the side of those people allocating,
because even if you're on a really good investment board,
and you're an allocator, and you're head of US equities,
or you're head of alternatives or bonds,
or whatever it might be, you have a benchmark.
And if you haven't beaten your benchmark for the last three
years, I'm not saying at the good places,
they throw you out.
But I am saying they don't throw you a parade, OK?
So it's very, very hard on that.
So one thing you could do is do it yourself.
And I wrote this other book that you have,
"The Little Book That Beats the Market."
And I just did a simple formula that
sort of was like the jellybeans, counting the rows,
going across, and just picking the cheap companies to buy,
very simple.
And I wasn't running outside money at that time
that I wrote the book in 2005--
just wrote up the very first study we did
of doing something cheap and good.
Businesses just made it pretty easy
for you to buy a handful of those.
And I kept getting phone calls-- hey,
could you just do this for us?
And so what I did was I set up a website
that listed the top stocks.
It's still going around, MagicFormulaInvesting.com.
And people said, yeah, that's fine.
But could you still do this for us?
So I set up something called formula investing.
And I gave people two choices.
I said, well--
I sort of viewed it as a benevolent brokerage firm.
I said, listen, we'll let you do this yourself.
But you have to choose from this top list of 30 or 50 stocks,
and you have to choose at least 20 of them, OK?
Stay out of trouble, and you're supposed
to invest every quarter, update your portfolio,
and just mechanically do this.
You don't have to buy everything,
but you have to buy at least 20.
And then the person who was running this
for me said, you know what?
How about you just add a check box which said,
just do this for me, just automatically buy it.
So just as an afterthought, I said fine.
We'll do that too.
So we ran this for a couple of years,
and let me tell you the results.
The people who chose their own stocks
from the pre-approved list of the top stocks,
they did pretty well.
For the two years, they were up 59%, roughly.
Unfortunately, the S&P was up 62% during those two years.
The automatic, just do it for me-- that was up 84%.
So the automatic had beaten the--
in other words, just buying the list
had beaten the market by 22 points.
But by giving people any discretion,
even though the list was pre-approved, just by picking
and choosing the ones that they didn't like-- but they had
to buy at least 20-- they had managed
to take a 22% out-performance in a couple of years,
which is pretty good, and turn it into a 3% under-performance.
So do-it-yourself-- I wrote a piece for Morningstar
called "Adding Your Two Cents May Cost You a Lot."
And so I just wanted to caveat that.
So another way-- let's see, I'll do this fast.
I wrote a book [INAUDIBLE] mentioned, called "You
Can Be a Stock Market Genius."
World's worst title of all time, but in it,
it said sort of what Warren Buffett calls,
why don't we look for one-foot hurdles, OK?
And I opened the book with a story about my in-laws,
who used to spend--
they had a house in Connecticut, and they
used to spend the weekends going to yard sales and country
auctions looking for bargains, OK?
Paintings or sculptures-- they were art collectors.
And I described what they were actually doing.
And they were not going to these yard sales and country
auctions looking for--
seeing a painting that was discarded, saying,
this guy's the next Picasso.
That's not what they were doing.
What they were looking for are pieces of art or sculpture
that they know the artist.
Some of his similar work had just
gone for auction for a lot more than they could buy it for,
right?
They could buy it for 30 or 40 cents
on the dollar for what it just went to auction for.
That's a lot different question.
And so what "You Can Be a Stock Market Genius" was,
was showing you these areas that are ignored.
These are the country auctions and the yard sales
of the investment world.
And these were--
I talked about different areas, spin-offs, bankruptcies,
small-cap stocks, companies going
through recapitalizations, anything
weird, complicated situations.
So that's another way, but you guys have a full-time job.
That is a full-time job, let me tell you--
that's a full-time job.
So right now we run mutual funds.
I can just tell you some of the struggles
that we have with investors.
We do follow that chart, choose from the 2,000 largest
companies, and we've had a nice record.
But there are years like 2015 where
there's a benchmarking issue, meaning the S&P 500 in 2015
was up roughly 1.3%.
The equally weighted Russell 2000 was down 10.
The equally weighted Russell 1000 was down 4.
So if you're picking from roughly the 2,000 largest
stocks, an even performance would be down 6 or 7,
not up 1.3.
So there's a benchmarking issue, but to beat the market,
you have to do something different.
You're going to zig and zag.
Everyone knows that.
We're now working on something-- we've
had something open a couple of years
where we sort of say, OK, we'll start with the benchmark,
and then we'll value-add.
And we'll make some compromises so that we don't--
it's called Index Plus--
and so that we don't vary too much from the index.
So you can stay with us, and the thesis was basically--
the best strategy for you, which is
how I'll end before I take questions,
is not only one that makes sense,
but one you can stick with, OK?
So you have to understand what you're doing, number one.
If you give it to someone else, you
have to understand what they're doing.
And you have to be able to stick with it,
so you have to understand it well enough to stick with it.
So that's, I guess, before I take questions
what I will leave you at.
And maybe [INAUDIBLE]--
SPEAKER: Yeah, thank you so much.
That was great.
[APPLAUSE]
So let me set up the chairs.
So thanks again.
In reading your magic formula book,
"The Little Book That Still Beats the Market,"
I noticed that you mentioned that there were questions
about whether one should short stocks, the most expensive
ones, through the same metrics.
And you had, I guess, not explicitly said
that that's the way you'd want to go.
And correct me if I'm mistaken.
And then you started the formula investing funds as well, which
you alluded to in your talk.
However, what has happened to them?
Are they still continuing, and what's
your vision for that going forward?
JOEL GREENBLATT: Sure, we opened long-only funds,
called formula investing.
And we just merge them with our long-short funds.
So we have long-short funds that run 100% net long.
But when we looked at their performance,
we did better in up markets with the 100%
long, long-short funds.
We had a long-short overlay in up markets and down markets.
Pretty much, we never did better the other way.
And so we just merged our simple 100% long
into the 100% long that also did long-short.
So it was just a matter of trying
to put our best foot forward and managing the things.
We actually-- we had just been rated the number-one fund,
had gotten five stars from Morningstar
for our formula investing fund, and we closed it.
And we merged it with our long-short funds.
It wasn't really a business decision.
It was really a decision that we want
to put our best foot forward.
And so that's why we did that.
SPEAKER: So when you talk of long-short,
how do you decide between 1/70/70 distribution or 1/40/40
distribution.
When you're saying you're net 100% long,
how do you come at what the ratios should be?
JOEL GREENBLATT: Sure, so what [INAUDIBLE]
is mentioning is that-- well, what he means is,
let's say you give us $1.
We'll go buy $1 of our favorite stocks.
Then we'll go out and buy $0.70 more of our favorite stocks,
but this time we'll pair them with $0.70
of our least-favorite stocks.
We'll short them, so we'll be 70 long and 70 short,
and so another bucket to add return.
And why isn't that 40/40?
We picked ratios for most of our funds
that we thought made sense, given how much volatility you
added by the amount of leverage you're adding
and the amount that you're shorting.
There's not a big magic to it.
Something that worked well at $1 long with 70/70 or 40/40--
they both work well.
In our large-cap universe, we give people choices.
SPEAKER: Mm-hmm-- so Joel, there are
a bunch of questions around the same theme.
I guess we can sort of package them into one.
People are curious to know, what do you think of the market's
valuation today?
Where do you see value areas today?
JOEL GREENBLATT: Well, the benefit of having--
we have a big research team, and we have a lot of history on--
if you want to think of the S&P 500, those 500 companies.
So we actually go back 25 years and look
at each individual company every day for the last 25 years
and aggregate them in the weights of the S&P 500.
So what that allows us to do is go look at today--
where's the valuation of the S&P 500 today, contextualized,
versus the last 25 years?
And so what I can tell you is, we're in the 17th--
it's not a prediction.
I'm just giving you some facts.
The way we value companies, we're
in the 17th percentile towards expensive
over the last 25 years.
That means the market's been cheaper 83% of the time,
more expensive 17% of the time.
When it's been here in the past, year-forward returns
haven't been negative.
During that 25 years, the market's been up about 10%
a year.
So right now from these valuation levels,
what's happened in the past--
over the next year, up 3% to 5% on average;
over the next two, up 8 to 10, so like I said,
not a prediction.
But if you want to know what has happened to stock prices
from similar valuation levels over the last 25 years,
that's what's happened--
3% to 5% positive return on average over the next year,
and 8 to 10 over the next two.
SPEAKER: So there's one question around what you
were doing in the first 10 years of investing,
when I think you averaged 40% to 50% annual gains after fees.
Correct me if I'm wrong.
What was the strategy that you and Rob Goldstein
were following in those days, and what parts of that
are actionable for the individual investor,
compared to the Index Plus strategy?
JOEL GREENBLATT: Sure, so stock investing is figuring out
what a business is worth and paying less,
and so that hasn't changed.
What makes a company worth something
and what makes it cheap relative to that
is pretty straightforward.
That's sort of Ben Graham-- figure out what it's worth,
pay a lot less, leave a large margin
of safety between those two.
Warren Buffett added a little twist
that made him one of the richest people in the world.
He simply said, if you can buy a good business cheap,
even better.
If you read through Buffett's letters,
it's very clear what he's looking for--
first thing he's looking for, anyway,
is businesses that are in high returns, we call it,
on tangible capital.
And that just means every business needs working capital.
Every business needs fixed assets.
How well does it convert its working capital
and fixed assets into earnings?
So the example I used in "The Little Book," which I really
wrote to explain these kind of concepts to my kids--
I said, imagine you're building a store,
and you have to buy the land, build the store,
set up the display, stock it with inventory.
And all that cost you $400,000.
And every year, the store spins out $200,000 in profits.
That's a 50% return on tangible capital.
Maybe I should open more stores--
not so many places I can reinvest
my money at those rates.
Then I compared it to another store.
Remember, I wrote this for my kids.
And I called that store Just Broccoli.
It's a store that just sells broccoli,
and it's not a very good idea.
Unfortunately, you still have to buy the land, build the store,
set up the display, stock it with inventory.
That's still going to cost you roughly $400,000.
But because it's kind of a stupid idea
just to sell broccoli in your store,
maybe it only earns $10,000 a year.
That's a 2 and 1/2% return on tangible capital.
And all I simply say is, I'd much
prefer to own the business that can reinvest its money--
all things being equal, much prefer
to own the business that can reinvest
its money at high rates of return
than much lower rates of return.
And so that's sort of the Buffett twist
that we incorporate in the companies that we invest in,
by being very tough on the way companies
earn and spend their money.
So we tend to get a group of companies
that are not only cheap, but also deploy capital well.
And that's really what we're looking for.
So we've always done that.
"The Little Book" was more of a way to systematize that.
But in "You Can Be a Stock Market Genius," which--
what did we do in the first 10 years?
I wrote a book about it.
It was "You Can Be a Stock Market Genius."
It was looking for off-the-beaten-path,
more complicated things that other people weren't looking
at.
Something strange or different was going on.
I showed people nooks and crannies
in the market, where they could look for those.
The issue there-- and there is no issue.
It's a great business.
But our portfolios were 6 or 8 names,
were 80% of our portfolio.
We returned half our outside capital after five years.
SPEAKER: Five years.
JOEL GREENBLATT: We returned all our outside capital
after 10 years--
SPEAKER: 10 Years.
JOEL GREENBLATT: Between '85 and '94--
we were lucky enough to have enough money to keep our staff
and continue to run our money thereafter.
Warren Buffett said a fat wallet's
the enemy of high investment returns.
And so when you have a very concentrated portfolio,
and you're looking off the beaten path, where there
are smaller situations and things that are more obscure,
you're very liquidity-constrained.
That's why we kept returning money,
but that's not why we're doing what we're doing now.
If you're going to run other people's money,
this is what I'll tell you with a portfolio that
has 6 or 8 names that are 80% of your portfolio.
Every two to three years, usually within two, Rob and I--
my partner, Rob Goldstein, and I would wake up,
and we'd find out we just lost 20% or 30% of our net worth.
And that happened like clockwork every two or three years--
just always happened.
It has to happen with a concentrated portfolio,
either because we were wrong on one or two of our picks,
or market--
they were out of favor for some period of time.
And maybe it bothered us, maybe it didn't if we just
had to be patient.
But I would say for outside, when
I was talking about people going in and out of funds
and losing their turn, that is not conducive for other people,
especially if they're not doing the work.
It was OK for us, and I think it was good for us
because we knew what we owned.
And so as long as the facts hadn't changed, and as long
as we believed in our thesis, we could take that.
I wouldn't say it was easy, but we could take that.
Now, our bad days, we have hundreds
of stocks on the long side and hundreds
of stocks on the short side.
We're trying to be right on average.
We're buying cheap, good companies.
We're shorting companies that are
either destroying capital, or losing money,
or whatever it is.
And over time, that pays off.
But our bad days, with hundreds of stocks on the side,
are 20 or 30 basis points of under-performance, not 20%,
30% of our net worth.
And so I think for most people, it's a smoother ride.
And one of the great lessons that young investors--
and a lot of you guys are still very young--
can learn are the compound interest tables.
If you can make mid-teen returns--
wouldn't make 40% or 50% annualized returns,
but in mid-teens returns, if you know compound interest tables,
you can do very well with a smoother ride
over a long period of time.
One of the best examples-- and when I taught those
ninth-graders, I actually put on the outside
of their notebooks--
I handed them notebooks.
And I on the outside, I had a compound interest table.
And it had the example of starting investing $2,000
a year when you're 19, in your IRA, until you're 26--
so seven years of putting away $2,000--
and never putting another nickel in again,
or starting when you're 26 and putting in $2,000
a year for 40 years, until you're 65.
So the people who put in $2,000 a year from age 19 to 26
and never put in another nickel ended up with more money
if you earn 10% a year on that money.
They ended up with more money with those seven payments
than the people who start at 26 and put in 40 payments,
till they were 65.
You end up with more money, the 19 to 26--
just a very important lesson to learn about starting early.
I know all of you are over 19, so I'm
sorry I didn't tell you this.
[LAUGHTER]
But these kids weren't, and so compound interest tables
are important.
So you're young-- if you stay with a very methodical
investment strategy that makes sense over time,
you can all still do very, very well.
SPEAKER: So, Joel, thanks.
You've talked about the size effect, right?
Going into hidden places and obscure areas as well--
you also talked about the temperamental edge
that you can bring to the process of investing.
And then there is something to say about the analytical
and the informational edge.
And there used to be a lot of investing in net nets payback.
And do you think some of these edges
have become less relevant, versus more relevant,
over time, with information becoming almost universally
accessible?
JOEL GREENBLATT: Well, information--
people have information on the S&P 500 stocks.
There's still a lot of group-think going on.
What I tell my students is, some of these smaller cap--
you know what happens if you're very good at doing things,
like you read "You Can Be a Stock Market Genius"
and buy some of these things in these obscure places.
And what I would call it is taking unfair bets,
not because you're so smart, but because you found it in a place
that other people aren't looking.
What happens to people who get good at that is they
get a lot of money, and then they
can't do that anymore because they have too much money.
So it opens a whole new area for young people
to keep coming into that.
So certainly, some of the smaller situations
will always be there.
Things may be a little more efficient,
But there have been plenty studies that--
one of the big chapters I wrote was on spin-offs,
which are companies that are sort of separated from--
and those still work very well.
But it sort of misses--
they've studied, if you bought all of the spin-offs,
how would you do?
And they continue to outperform.
That's not really the question.
The question is, is this an area ripe for mispriced securities?
If the average spin-off did average,
that wouldn't mean anything to me.
You're looking for the opportunity
where people are discarding things
or are just not interested in things
for reasons that don't have to do with the investment merits.
They may be too small.
It may not be the company that the people who owned
the original stock invested in.
Usually, you discard companies that are out of favor
at that time.
So even though on average, they've
continued to outperform pretty much as
well as when I wrote the book--
so that's not discouraging.
But even if they did average, they still
are ripe for mispricing, really what I'm looking for.
So you're looking in these areas that are ripe for mispricing.
You don't have to run a statistical model to decide
whether, on average, they do well or they don't.
If you know what you're looking for,
you're looking for opportunities to find
things that are mispriced.
And I don't think those will go away.
But as I said, there are higher and better uses
for most people's time.
So I had a ball doing that.
I have a ball doing what I'm doing.
If you don't want to do it, fine with me.
SPEAKER: In one of your recent interviews,
I think you mentioned Apple, one of the big companies.
And you think group think and mispricings can happen even
in big companies.
So maybe Apple or some other company--
I was wondering if you could take our audience
through an example of, what are the metrics one
should be looking at if they were looking at a company?
JOEL GREENBLATT: Well, I'll pick Apple as just big, big picture.
You guys have heard of that?
[LAUGHTER]
So at least I'm old enough to have had a BlackBerry.
And it used to have 50% of the market.
Now it doesn't really exist.
It wasn't that long ago.
And the vast majority of Apple's profits come from their phone.
So that's the negative story on Apple--
it's a hardware company.
It's going to crash and burn like all of them do, OK?
On the other hand, some people might say, oh,
it has an ecosystem of products that play off one another.
They interact with one another.
It has a brand.
I always say, hey, Coca-Cola doesn't make sugar water,
and they have kept their brand pretty well.
People tend to like Apple as a brand.
And so the question is, which is it?
Is Apple a hardware company, or is it
an ecosystem of products with a great brand name?
I'd say the answer is probably gray, somewhere in between.
It's not either one.
It's probably somewhere in between those two.
But if you took a look at the market,
I can look at where the S&P is trading.
I can look where Apple's trading.
And a few months ago-- it's still very cheap,
but a few months ago, it was trading at less than half
of the valuation of the S&P. So at a price,
my answer is, if it's somewhere in between,
I'd say it's probably better than average.
And I'm getting it at half price.
I don't know if that's right, but I
have a large margin of safety.
I own hundreds of--
what I say is, what we do now is,
I don't know the answer to your question.
It's gray.
I don't know the answer.
I don't know if it's closer to a hardware company.
I don't know if it's a ecosystem with a brand attached,
and so it's much, much better.
But interest rates are 2%.
It's got a 10% free cash flow yields,
earns high returns on capital.
It's got a great niche.
What I would say is, I don't know if Apple's going to work,
but I don't own just Apple.
I own a bucket of Apples.
I own a bucket of companies with metrics
like that-- trading really cheap, with deploys capital
well, with nice potential prospects.
And so I don't know if Apple's going to work.
I know my bucket of Apples is going to work.
That was the chart I showed you.
And so we own the bucket of Apples.
But if you ask my bet on Apple, I
think it's cheap, relative to other choices right now.
SPEAKER: Fantastic, I just have a couple of questions,
Joel, quickly.
You mentioned index fund in the beginning of your talk.
With all the money flowing into passive funds, ETFs,
and index funds, what would be your contrarian moves
during a period like that?
Are there things investors should be cautious about,
for example?
JOEL GREENBLATT: Well, I told you
where I thought the market in general--
it's a market cap weighted index, S&P 500 was expensive,
but still expecting positive returns going forward.
It's a world of alternatives.
So the question is, how should I invest my money?
The move to passive can, with all the ETFs and everything
else, can cause dislocations in the short term,
because people are not discerning.
Remember, I said stocks are not pieces of paper
that bounce around, that you put Sharpe ratios and Sortinos on.
They're ownership shares of businesses, and businesses--
there's a dispersion in their fundamentals, how one is doing,
versus another.
When you just take an ETF and don't
discern between the differences in the fundamentals,
that can cause dislocations in the short term.
That just makes me smile more because those dislocations
mean, hey, I can find bargains because people
stopped thinking.
But I don't think they're at such an extent,
other than in the short term.
I think you're familiar-- when the market falls,
and everyone gets depressed all at once,
they say correlations go to 1.
That just means everyone throws the baby out
with the bathwater.
They make no discernment.
But that really just happens for the first month, maybe two
at the most.
And then there starts to be discernment.
That's actually the best opportunity time for us,
when people start discerning again.
And you just had everything move together, which it shouldn't.
They all have different prospects.
And so the same with ETFs, if there's flows
into them or the indexes--
that could cause short-term dislocations
over a month or two, but those get corrected over time.
Like I said, the market eventually gets it right.
There's a lot of--
just think of the jellybeans.
You really get it.
It's the jellybean effect of when everyone hears
what everyone else is thinking.
That happens most of the time.
That's what the stock market is.
Your job is to be cold and calculating and unemotional.
Unfortunately, people are human.
It's good news for us, but people--
the stats are against you.
That's why I think the indexers get
it right for the wrong reasons.
They mostly are saying the market's
efficient and have other explanations of why
you can't beat it.
I think the market often gives you opportunities,
but it's very difficult to take advantage of them
for behavioral and agency problems.
And those are much more powerful than you
would think by just saying, oh, behavioral and agency problems.
The people are people, and it's been happening forever.
I don't think it's getting better.
I think time horizons are shortening.
There's so much-- all that data, all that-- look,
when I started my first firm in 1985,
I used to write quarterly letters.
And they read something like this--
we were up 3% last quarter, thanks a lot.
That's what it sort of said.
Now we have $10 and $20 billion endowments that
need to get our results weekly.
I don't know what they do with them.
[LAUGHTER]
But we now have to do that, and most of them
do a good job with it.
But that's just the way of the world.
So if you keep measuring things in shorter periods,
and you can measure them, and there's more data,
it doesn't make it better.
It makes you more susceptible to emotional influence.
So that world's getting better.
The last man standing is patience.
We call it time arbitrage.
Other people call it time arbitrage-- just being patient.
That's in really short supply, and it's not getting better.
Things are moving to faster and less patience.
So that's really the secret.
So now you don't have to even read
the big secret [INAUDIBLE].
SPEAKER: I think one fantastic gift you've
given to the value investing community
is the Value Investors Club.
I'm sure most people here have already visited the website.
If you have not, please check it out.
It's an amazing resource.
Joel, if you could maybe just say
a word about the Value Investors Club, what's
your vision with it going forward?
And how does it compare or contrast it
with other investing platforms that are emerging these days?
JOEL GREENBLATT: Sure, well, it originally started in 1999.
And the whole big thing with the internet
back then was getting millions of eyeballs to look.
And I viewed it more as a, wow, I always wanted
to be in an investment club.
And I thought, hey, I could form an investment club where
you can meet any time, at your convenience,
wherever you are, were, and share ideas
and back and forth about it.
And I'm always grading papers at Columbia for my students.
And at the time, there were Yahoo message boards
where 99.9% of the stuff was not worth reading.
So I sort of said, hey, why don't we--
along with my partner John Petry,
I said, why don't we vet the people who can join the Value
Investors Club?
And if you would have gotten-- maybe two or three people
in the class each year would get an A-plus.
And if you could write up an investment thesis
that I would have given an A-plus to in my class,
you can join the club, and it's free.
The only thing that you have to do is share your best ideas.
You have to share a couple of your best ideas
during the course of the year, and that
entitles you to see everybody else's good ideas.
And so it's just merit based.
And still only 1 out of 20 applicants
get in, so I think it's a little harder than Harvard.
I don't know.
[LAUGHTER]
But it's been going now for 16 years.
We do have a--
I think it's a 45- or 90-day delay
that if you're not a member, but to get the live stuff,
you have to be a member.
So learn how to value a business and apply, if you like.
There are instructions on the website.
It's called the Value Investors Club.
But as a learning tool, I always refer people there
because these are very smart investors.
They beat each other up.
There's a Q&A after they post something, and say,
what about this?
What about that?
A great rating out of 10 is 5, because everyone's
mean and very--
they're value investors.
They're very tough and stingy.
And so they don't--
so if you look at the ratings and see anything a 5 or above,
that's good, these guys.
And you can look at that.
It's just a learning exercise, right?
It's teach a man to fish.
That's really how to be good at investing.
It's not anything else.
You've got to understand what you're doing.
It's a great way to learn.
So I think for the next generation,
it's a nice way to teach them to look
at what smart investors are doing now--
doesn't mean I agree with everything on the site.
And this is a good point.
I'm probably wrong more than I'm right about passing on things.
But Warren Buffett calls it no called strikes on Wall Street.
You could let 100 pitches go by, and you
should've swung at 30 of them.
But if you only pick one, and you
make sure that's a good one, that's really the way
that we go about investing.
I just have to--
my partner Rob Goldstein and I are very tough on each other.
So we both have to like it.
We both have to argue our points.
And if we both like it, we think it's pretty good.
So we're really, really picking our pitches.
It doesn't mean we don't miss a lot of good ones.
It doesn't matter if we miss them.
It just matters the one we pick are good.
And that's sort of the way to think
about "You Can Be a Stock Market Genius" type of investing.
What we're doing now in our long-short portfolios
is more being right on average.
I showed you that chart where we're pretty
good at valuing businesses.
So we buy a group of businesses where
we have a bucket of Apples.
And we're short a bucket of high-priced companies.
We're going to be short some things that lose money,
or the Teslas and Amazons of the world, who are selling
at 100 times free cash flow.
And people get confused, because I call that
the tyranny of the anecdote.
It's we will short some wrong ones.
We won't short much of them, but we'll short some,
and we'll be wrong.
And you'll know their names because those were the winners.
But if you're short hundreds, take my word.
It's not a good idea to eat through cash,
or lose money, or sell at 100 times free cash flow.
And usually, if you're generating lots of cash,
and you can buy that cheap, and they're
deploying their capital well, that's a good thing to do.
And so we're just trying to be right on average.
Two different ways to do it, doesn't make
one better than the other--
there are different ways to make money.
I love them both, would do both again.
They're just both full-time jobs.
SPEAKER: Great-- and, Joel, our final question
goes maybe one step ahead into valuation.
In your books you've spoken about different kinds
of multiples that are used to value companies.
You've spoken about enterprise value to free cash flow,
for example EV to EBITDA is one of those multiples.
And lots of such multiples, you say,
have been proven effective for long-term investing,
as you're buying a bucket or a basket.
However, the question is, due to the lack of a single source
of accurate benchmark markets-- because there are one-off
charges and things you have to clean up for--
there are many sites on the web claiming
a wide range of numbers, some good, some not so much.
Have you thought of having a standardized, maybe
open-source, implementation to benchmark these metrics
over the long term, in the same spirit of magic formula
investing, for example?
JOEL GREENBLATT: OK, I think I'm a nice guy, but not that nice.
[LAUGHTER]
So we have a team of analysts.
We go through every balance sheet, income statement, cash
flow statement in the companies we look at.
What's that deferred tax asset, or pension liability, or off
balance sheet plant in Taiwan?
How should we handle that?
How efficient are they at using and spending money?
We do all that work.
When I wrote "The Little Book," I
called that the Not Trying Very Hard method.
It worked incredibly well using rough metrics--
the type you're talking about, Rough metrics--
and it worked incredibly well.
My partner Rob and I looked at each other and said,
this not only worked well.
It worked much better with those, not trying very hard,
than we even thought.
Can we improve on that?
We actually know how to value businesses.
Can we just go do that?
And we put together a research team, and we do that.
It would be really nice if I shared that with everyone,
but it's a lot of work.
And the other way works incredibly well.
SPEAKER: You're a nice guy.
[LAUGHTER]
JOEL GREENBLATT: I am a nice guy,
and so we're trying to treat our clients really well.
[LAUGHTER]
SPEAKER: On that happy note, thank you so much, Joel.
It's been a pleasure.
JOEL GREENBLATT: Thank you very much.
Thank you.
[APPLAUSE]