Joel Greenblatt & Howard Marks Discuss Value Investing

it's a real big great pleasure for me to have Joel here spend the next hour with us I got to know Joel about 25 years ago through a mutual friend there is an unusual cluster of successful investors at Wharton at the end of the 70s if we have time we have made explore the what was in the water at the time but Joel was one of them and certainly among the most successful and you know I got to know Joel socially but then he convinced me to come up to Columbia and teach a class for him and his value investing course once a year which I'm glad to do and he very graciously reciprocated here today and it's you know this is a supposed to be a lecture series for outstanding investors and Joel certainly is one I have a bunch of questions here which I wrote out and I thought they'd be great Joel says yeah they'd be fine but then my son Andrew Penn class of o.9 wrote me his today and is it much better so so we're going to go through Andrews questions and joel hasn't had the benefit of seeing him so his answers will be fresh and spontaneous and if you don't if you don't mind I think Andrew put them well so I'm just going to read them to you sure you wrote the book on special situations investing in numerating a number of ways to make money from spin-offs recaps reorg bankruptcies mergers and the like given that you wrote the book and thus there were no books before you wrote yours how did you figure out how to invest in this way how did you figure out what was important and where you could and couldn't make money well you're right that is a great question well I actually started my first job was with they didn't call them hedge funds back then but it was with a risk arbitrage firm and risk arbitrage otherwise known as merger arbitrage involves buying a company after a merger deal is announced and hoping that it closes and generally the risk reward in that business is well if it the merger closes you make $1 and if it breaks you lose ten or fifteen dollars and that risk reward wasn't that appealing to me and so I started looking for other ways to do it so I looked for mergers that had interesting securities I you know coming off you know the way they were paying for the merger I looked for extraordinary events happening within companies whether recapitalizations or spin-offs or anything where I could get out of the business where I could make a dollar and lose 10 or 15 and so I was just looking for things that were a little off the beaten path I really started learning when I was at Wharton and at the time Wharton was really in the efficient market camp the way they were teaching things and it didn't resonate with me and my junior year I happened to read an article about a guy named Benjamin Graham and as soon as I read that article I said ah this makes sense to me and I started reading everything that he wrote and started looking at the world really through a different lens and that lens was not the first job I took which was risk arbitrage it was really looking for figuring out what something is worth and paying a lot less leaving leaving a large margin of safety and so these special situations gave me that opportunity I opened up I opened up that book you can be a stock market genius one of the worst titles ever given to a book it was supposed to be any fool can be a stock market genius and then my editor had the Motley Fool's at the time which was very popular so he said well you can't use the word fool and so my dad said how about you can be a stock market genius and then in parentheses even if you're not too smart and so I giggled a little bit and they only gave me a day to change the title so I just went with it and that wasn't a good choice but I but but i but I opened the book with a story about my in-laws who spend they used to live in Connecticut for part of the year and they would spend their time antiquing going a country auctions going to tag sales and they were looking for art and antiques that were undervalued and when they found a painting at a country auction or at a tag sale they the question they asked was if they saw a painting by an artist and they had seen that that artist had just gone for auction with a similar type painting similar size similar genre or whatever it was and it had sold at auction recently at two or three times the price that they could buy it for they would go buy it that's a lot different question than asking is this painter going to be the next Picasso that's a much harder challenge so I opened the book saying special situation is a little like that you know you don't want to be so smart to know who's going to be the next Picasso you sort of want to look a little off the beaten path because this is a little more obscure it's smaller market cap it's something strange is going on and the normal people who follow this aren't going to look at it because it's too complicated or you got to read a 400 page thing or you know the piece being spun off is is not really why people bought the original stock in the first place it's for the small not for the little small business that's being spun off so these were discarded things so it was my way of making the challenge easier finding things that were selling well below their fair value no it wasn't so much you know I finished that first chapter of you can be stock market genius with the story about the plumber who comes to your house and bangs on the pipe once and says that'll be $200 you know fixes your pipes and says that'll be $200 and and you say to the plumber what do you mean $200 you came here and banged on the pipe once he says oh no that's only five dollars it's one hundred ninety five dollars to know where to bang so so that's how I view special situation investing just making the challenge easier and so I'd rather be a little not as smart and a little bit lazy but go for you know Warren Buffett would call them one foot hurdles why go around looking for ten four foot hurdles to jump over if you could find some one foot one so I don't have to be all that smart to be good if I'm looking in the right places you know Joel I wrote a memo in January of 14 called getting lucky and I told the story of a guy who was working on becoming a better poker player so he's working on learning the odds of getting the cards you need the odds that the hand you had would beat other hands the tells that tell you whether the other side is bluffing or not and his uncle said to him you're wasting your time trying to become a better poker player why don't you just find that easier game and it sounds to me like what you did is look for what you thought were easy games yeah it's a you know the the last story I told in the book that illustrates the same point is I tell story that I lost a bet and the loser had to take a the winner to the best restaurant in New York at the time it was the test there was a chef they are andre soltner which at the time was considered probably the world's greatest chef and so first i called up and they wouldn't give me a reservation you know i thought i said i'll take any time any day and they said sorry and III didn't understand that and it turns out you know there's some 30-day period where they'll only book for 30 days and they were all booked so I kept calling back finally got in we get to the restaurant and I wasn't really pension paying attention to who came over to take my order but I pull out my manual and point to one of the appetizers and I said innocently is I pointed to one and I said is this one any good so andre soltner turns to me and says no it stinks so you know best chef in the world I'm asking if you know this thing he just cooked is is any good and so the point was I think the point he was making was everything on the menu is good this is the best restaurant in the world and so I try to shop in in the best places where almost everything is good and I just have to discern between a bunch different good so Joel you you mentioned buying things for a lot less than they're worth and that that provides the margin of safety yeah would you say that those are the core elements in value investing and and you want to enhance that definition and or is that enough well and another question you mentioned that you didn't think it would be a great idea for your in-laws to try to find the next Picasso would you analogize that to growth investing um sometimes I mean my definition of value investing is figure out what it's worth pay a lot less it has nothing to do with low price book or low price sales and so that's how a lot of people like Russell or morning star would classify value investors and so they probably wouldn't classify me as a value investor or a growth investor they kind of don't know what to do with us and you know as Buffett has said you know growth in value or are tied at the hip I mean a part of what makes value is by investing in a business that can grow over time so they're they're not two different way they're classified by let's say Morningstar Russell maybe there's much lower growth in value and much higher growth in growth and they they make it that way but I'm looking for good businesses that are cheap you know Ben Graham said figure out what it's worth pay a lot less leave a large margin of safety uh between those two big space between those two things Warren Buffett his best student made one little twist that made him one of the richest people in the world Buffett simply said if I can buy a good business cheap even better part of good is a business that can grow over time and so I slowly gravitated not not fast enough I you know certainly in my first decade of investing gravitated more towards the way that Warren Buffett invest he's looking for good and cheap businesses and growth this is part of sometimes being good but at the beginning Buffett wasn't so entranced with good businesses he was famous for starting off with the cigar butt approach where he wasn't looking for quality he was just looking for cheapness but then he too transition yeah I mean my master's thesis at Wharton or it turned into that with my friend rich buzina and Bruce Newberg was a paper we wrote that eventually got published in the Journal of portfolio management about buying cigar butts you know they were called net nets buying stocks selling below their liquidation value and showed that just buying if you bought a cheap enough you could make nice money and and that's sort of the way Warren Buffett started but when you think about why we move too towards quality let's say you find a stock that's worth ten dollars and it's selling at six it's pretty cheap but if you're not controlling the business and it's not in a good business your margin of safety may erode over time meaning that ten dollars could turn to eight if you're not really controlling those assets and what you're really looking for businesses or what looks better to me anyway are businesses where that ten dollars might be growing to eleven or twelve increasing your margin of safety so I might take a lower margin of safety if I thought that was growing but there's there's more buying things cheap works I mean cheap alone works I have nothing against it it's just that you have to get out of it so Buffett who runs a hundred billion dollars or some number like that it's not easy to go spend five billion and then go sell it to some other guy who's going to you know pay you more than the five billion it's too big so when he was and he said as recently is you know around year 2000 he said well if you give me a million dollars I can make 50% a year on that there's plenty of opportunities your opportunity sets shrinks as the businesses become larger if you can invest in anything you know if you don't have a lot of money you can invest in thousands and thousands of businesses Buffett is now looking at the top 300 businesses in sides because the smaller ones aren't they won't move the needle so there's a lot you can do in special situations one thing a lot of my students ask me you know when it happened it happens every year now probably for the last five or six years and they and the question they ask me at some point in the semester is that you know when you were younger because you're really old they leave that part out but you're really old and when you were younger things were easier that goes unsaid what well I just said it but anyway things were easier there was less competition there were less hedge funds there were less computers there were less smart guys going into this business I mean when I got into it I was telling Howard before market hadn't gone up in 13 years by the time I got to Wall Street so it wasn't a place that really was attracting lots of people so they said it used to be easier for you but you know it must be hard for you know hey you stupidly wrote a book about this and there's a lot of people doing this now not just because of that obviously um you know it's harder for us you know you you got the easy stuff and so my response is this people who are very good especially in special situations --is one is people who are good at special situation investing really looking off the beaten path for liquidations or recapitalizations or spin-offs or any of those things many of them are liquidity constrained you know Warren Buffett started making a lot of money doing those things but he grew too big and so I asked I tell them that listen you know what happens to people who get very good at analyzing businesses in this area what happens to them is they make a lot of money and they get too big to stay in this area so there's always a new group of people who can come in and look at some of those smaller situations because the guys who are really good at it get too big to to really take advantage of some of the smaller or more obscure situations and so there's always room for new people to come in that area and then on a larger scale you know because people still teach efficient markets and they'll say hey you know active investing doesn't work and even more than Buffett saying go buy some ETFs or you know indexes and everything else and what I'll say is that for most people that's true because they don't know how to value businesses but I will give you a counter and this is what I tell my students and most of my students around 27 ish or something like that so I said I tell them all let's go back to when you were roughly 10 years old where you might start noticing some of this thing and let's go look at the most followed market in the world and that would be the United States and let's go look at the most followed stocks in the most followed world in the most followed market in the world and that would be the sp Hunter stocks to a large extent let's take a look at what happened since you were 10 years old take a look at the S&P 500 from 1996 to 2000 and doubled from 2000 to 2002 had halved from 2002 to 2007 it doubled from 2007 to 2009 it halved from 2009 till today it's basically tripled that's my way of saying people are still crazy and that's really unfair thing to say because this S&P 500 is an average of 500 stocks there's huge dispersion going on within that average between stocks that are in favor that people love emotionally and socks that people hate so it's really much worse than what I just described there's huge dichotomy between things people like and people don't things that are in favor out of favor within that that is all this noise is going on within that at average that average is smoothing things so if you believe what Ben Graham said is you know here's fair value and here's what the market prices are it's like a wave around fair value and if you have a discipline way to value companies and buy more than your fair share when they're down here and sell some maybe if you're shorting it wouldn't win and you're very disciplined I mean I make two guarantees to my students first day of class first guarantee is this if they do good valuation work I guarantee them the market will agree with them I just don't tell them when could be a couple weeks could be two or three years but I tell them the market will agree with them and that and the corollary to that is this and it's very powerful I tell them in 90% of the cases for an individual stock two or three years is enough time for the market to recognize the value they see if they've done good work when you put together a group of companies that actually on average is actually happening quite a bit faster so you know both those are very powerful just as good work will be rewarded so I don't think the reason people don't beat the market is because the market is efficient or even close to efficient or not emotional it's very emotional or that it can't be done there's all kinds of institutional and agency reasons and tons of other reasons why they don't do it but because prices are efficient if you just pick up the paper or observe what's going on or listen to what I told my students since you know when they were 10 years old it's pretty clear that people are still crazy and there's opportunity out there Joe what are the things you wish you could go back and tell yourself when you were just graduating from Wharton me maybe you just told us all but other anymore and and when you were starting out on your career and investing well the first thing I would say is don't go to law school I went I went to one year law school and dropped out so don't do that I would say uh I was lucky there was something about investing in the challenge and figuring out the puzzle of you know how does this work or how does it you know you get to look at all these different businesses you get to figure out does this make sense or that makes sense it was just it was fun for me it everything that was going on in the world was relevant things I read in the paper things about different businesses learning you know it was I just enjoyed the challenge of investing from the start and I would say uh you know I got lucky I don't know if I I think I pursued it because I was pursuing something I really enjoy I've had about 800 students since I started teaching in Colombia and I would say since I started remember I said the market hadn't gone up in 13 years most people didn't go into Wall Street thinking they're gonna make a bundle at that time because no one really had too much market hadn't gone up in 13 years um and now you know I got lucky I got out at a time where the markets got straight up since so you can take anything I say with a grain of salt I did start investing at a very good time in my life and in the career and the and in the market but what I've noticed is that you know there is a lot of money to be made on Wall Street especially if you're good at this you get paid a lot more than you deserve for being very good at this kind of thing but I notice the most successful students are the ones who truly love what they're doing so what I would say to you I don't know don't go into this to make money there are you know you're all incredibly bright you wouldn't be here otherwise and there's many great things you can do in the world and do it go into it by all means I've had a ball because you think that this is this is fun and that you enjoy doing this for a living and I make my students promise that look I don't think there's a lot of social value in being good at picking stocks I mean people argue you're making markets and you're allocating capital well but I just assuming to do pretty well without us and actually we're not that great at allocating capital the markets going crazy a lot all the time but on average we are over time so there is that benefit but I think it would do fine without you so I tell them it's not the highest social value so I primate them promise that if they are successful at it and you know if I'm teaching them to do something I don't think has that much social value I'm one step removed from doing something that I think is that valuable so I make the promise to do something good meaning in other words to find something that's important to them that's meaningful to them to do with their success and then if you enjoy this career there's nothing wrong with it as long as you do it for love right not money there's plenty you all be successful doing whatever you do but do this one for that you really enjoy it that's great Joel if you look back over your career Canyon can you talk about a home run that sticks out how did you find it how did you build conviction oh well I can think of one that was actually the inspiration for the value investors Club we were just running our own capital we ran outside capital for ten years and we returned all our outside capital I didn't take outside capital again until 2009 to run directly anyway so this was during a period where we run weren't running outside a capital and uh one of my and so we were just looking for good ideas for ourselves and one of the we had figured out one of the best investments I had ever seen and it was a the reason it was so great was it was was a company selling at half its cash value with a great business attached okay and usually when I size positions it doesn't have so much to do my largest positions are not the ones I think I'm going to make the most money from my largest positions are the ones I don't think I'm going to lose money in so that I can buy a lot of that without taking much risk and if there's some optionality meaning it could go up and this had everything this I was buying at half its cash value with a good business attached it was a complicated capital structure that people couldn't figure out because it was relatively new and and people hadn't seen it but if you did that's what you were buying you you were buying something in half its cash value with a good business so obviously we bought a lot of that and we thought oh we're so smart one of the only people out there who's found this and then my partner found on a Yahoo message board of all places someone who had figured this out in all it's complicated glory and a funny story the gentleman who figured this out actually was working at a supermarket at the time it was just a really smart guy and it's a light bulb went off and we sort of said wow there's intelligent life out there wouldn't it be wouldn't it be great if we can put together a group of people who could talk and people at the time this was 1999 we're looking for millions of eyeballs on the internet and you know whatever they were talking about and I thought the internet was great to like have little meetings with people who are all over the country at different times or all over the world and and you could sort of have a little club I was always fascinated with a idea of investment club so we actually he was one of the first members of the value investors club and he got the idea of could we attract smart people to share ideas that was that was the deal was free to join but you had to share your good ideas and this gave us the idea that it wasn't just the normal hunting places that you could find really smart people who did good work so that was a really good one half its cash value and with a good business attached and it was really because it was a complicated capital structure uh the I wouldn't call my worst investment but I'd say my most disastrous investment anyway I've had a bunch of my partner Rob Goldstein join me in 1989 always joke that you know if we work for someone else over the last 15 years they would have fired us about eight times you know so you have you have to be willing to guess make mistakes and you can't really avoid it and so our worst one was probably we actually bought through a spinoff a company that actually owned Comdex which used to be a computer trade show and it was the biggest one and we were actually able to create it before the spin-off for about $3 a share and it was going to sell some new shares at $6 and that had been announced but yet we could create it by buying the parent and shorting another piece and creating what was left for about $3 so all good so far but we actually fell in love with the business what I loved about the business was that they ran this trade show in Las Vegas and you could rent all the trade space you wanted in Las Vegas at the time and it was available at about $2 a square foot and they could rear nted at 62 dollars a square foot so whenever the trade show grew they would spend another $2 and get a 62 dollar contribution and so we fell in love with the operating dynamics of this business and the the stock actually went from $3 it when they sold some more stock at 6 and the stock actually went to 12 and we had a really large position at $3 the reason for that is that we thought we could get out right away at 6 we did not get out right away at 6 because we fell in love with the business and went to 12 so it sounds good so far but then unfortunately after shortly after about September 9th 2001 the company bought another trade show and borrowed a lot of money and then after September 11th no one wanted to travel at all and both trade shows really went downhill and and everyone knows about financial leverage meaning you know hey you borrow a lot of money you pay your money you take your chances you you're put up a dollar you borrow nine you know that's a risky investment so this is how I learned about operating leverage which is when you lay out another two dollars and collect 62 when the sales go down right when you lose 62 dollars in revenue sixty of your profits just evaporated and it drops immediately to the bottom line that's called operating leverage so that was my lesson in operating leverage the stock I think I got out at a little over one or so so you know things happen you know this it's a lesson in concentration it's a lesson in operating leverage I've learned a lot of things and and I can still safely say I'm always learning I'm always making a new mistake I'm trying not to make the same ones but the same ones usually have a little different face on them you're really making the same one but you know it presented in a little different way and you didn't notice it and you would go make that mistake again and so I guess advice would be don't be shy about making mistakes because you will anyway Sarah Lyons I think that's very important with geologists and I want everybody the audience to take cognizance of it I wrote a memo in April called dare to be great and basically it said if you want to be exceptional as an investor you have to dare to be great everybody here is willing to be great but to be great you have to be different because if you think the same as everybody else you'll make the same actions if you take the same actions you'll have the same performance you certainly can't be exceptional if you follow the common course so to be exceptional you have to be different you also have to dare to be wrong and nobody bats a thousand the best baseball history hitter in history got four trips four hits every ten times to the plate right some investors can do a little better than that but nobody could Pat's a thousand and you know Joel mentioned that he could have been fired eight times and I have a very kind pasta tonight I let myself stay and I I had lunch today with the guy who works for Berkshire Hathaway and we were talking about what makes wines successful and I said one of the things that makes him say so he's not afraid to get fired but very few people have that luxury and the question is for those of us who work in the world where we can be fired if not by our employers than by our clients will we still take the chance and back our ideas that there are no sure things will you back the things that have a chance of being wrong and I think you have to take that chance finally Joel one last question and then we'll turn it over to the audience given that you had one of the best track records of all time why did you decide to give back outside capital when you did sure so uh that's kind of an easy one so I started my own firm in 1985 we returned all our outside capital ten years later at the end of 1994 during those ten years we had average 50% of year returns before our fees and then we gave back our money so there's only a few ways to make fifty percent a year one is to stay small so after five years in business we turned half our outside capital after ten years we returned all our outside capital the second way to do that is to be concentrated so traditionally six to eight ideas where eighty plus percent of our portfolio during that time so we stayed very concentrated the the third way was you get a little lucky right because you're very concentrated so you got to get a little lucky to do that but what comes with that style of investing with six or eight names even if you're great Nero usually right and everything else every two or three years without fail I would wake up together with my partner and we would lose at least 20 or 30% of our net worths because one or two of our positions were not going our way either market didn't like what we liked for that particular time and we just figured okay we own a cheaper we understood what we owned and we just don't a cheaper that's fine sometimes we made mistakes I never had a problem with that because I understood what we owned and I either made a mistake or I just don't a cheaper and I could live with that and I knew that was part of the game then you lose twenty or thirty percent of your net worth when you have other people's money it's not that comfortable you know I'm a big boy and I understand what I own and understand what I'm doing but when you have other people's money and and my investors had done well they they were all great actually it was really my self-imposed feeling bad when I would go through those periods for understandable reason a pretty competitive person I'd like to do well and that was uncomfortable losing money for other people so when we got to a big enough size that if I returned the money we could still keep our staff and continue doing what I was doing I thought I should do that because I figured I could either change my personality or change my circumstances and I thought it would be much easier to change my circumstances so I did that now we run long short portfolios with hundreds of stocks on the side and because our bad days are 20 30 basis points of underperformance I find that a lot more comfortable to run other people's money so we started taking other people's money again thank you well I think I think you've heard a really incredible example of how a great investment mind thinks very logical very insightful looking deeper into things than most people who that's really the answer you can't you can't say the same things other people see and expect to do better but also insight into human beings the people who make markets the reasons for error and coupled with it a real a real human being so I think we're very fortunate to have Joel here today

Channel: Wharton School

Views: 73,112

Rating: 4.9528794 out of 5

Keywords: Wharton, The Wharton School, Investing, money, hedge funds, mergers, securities, value investing, stocks, margin of safety, Joel Greenblatt, Howard Marks, interview, Columbia

Id: N-azmBU0yII

Length: 32min 37sec (1957 seconds)

Published: Thu Apr 09 2015

Reddit Comments

[u/knowledgemule]

what a great video. thanks!