[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]
Sad that his little funds haven't