The Little Book that Beats the Market | Joel Greenblatt | Talks at Google
Summary of "The Little Book that Beats the Market | Joel Greenblatt | Talks at Google"
Short Summary:
Joel Greenblatt, co-founder of Gotham Asset Management, argues that despite Warren Buffett's advice to index, there are opportunities to beat the market by investing in undervalued businesses. He explains his valuation methodology, which involves identifying companies that are both absolutely and relatively cheap, similar to how one would value a house. Greenblatt emphasizes the importance of patience and a disciplined approach to investing, as market fluctuations can make it difficult to consistently outperform. He also discusses the challenges of active management, including agency problems and behavioral biases, and highlights the importance of sticking to a proven investment process. Greenblatt advocates for a do-it-yourself approach to investing, using his "Magic Formula" as a starting point, and encourages investors to learn from resources like the Value Investors Club.
Detailed Summary:
1. Introduction and the Jellybean Analogy:
- Greenblatt begins by acknowledging Warren Buffett's advice to index, but then explains why he and Buffett choose not to.
- He uses a jellybean analogy to illustrate the difference between the "cold, calculating" guess and the "second-guessed" market.
- The jellybean experiment highlights the influence of external factors and herd mentality on market decisions.
2. The Opportunity for Value Investing:
- Greenblatt argues that despite increased competition and data availability, opportunities for value investing still exist.
- He uses the example of the S&P 500 to demonstrate the volatility and dispersion of individual stocks within the index.
- He emphasizes that stocks are ownership shares of businesses, and that good valuation work will eventually be recognized by the market.
3. Valuing Stocks: The House Analogy:
- Greenblatt compares valuing a stock to valuing a house, using measures of absolute and relative value.
- He explains that relative cheapness alone is not a reliable indicator of value, as seen during the internet bubble.
- He emphasizes the importance of using multiple metrics as checks and balances to determine fair value.
4. Empirical Evidence and the Long-Short Strategy:
- Greenblatt presents a chart showing the correlation between valuation percentile and year-forward return for 2,000 US companies over 20 years.
- The chart demonstrates that cheaper companies consistently outperform more expensive ones.
- He suggests a long-short strategy of buying undervalued companies and shorting overvalued ones, based on the chart's findings.
5. The Importance of Patience and a Disciplined Approach:
- Greenblatt acknowledges that the market doesn't always cooperate, and that short-term fluctuations can be discouraging.
- He emphasizes the importance of sticking to a proven investment process, even when it's not working in the short term.
- He argues that value investing, based on sound valuation principles, will eventually pay off over time.
6. The Challenges of Active Management:
- Greenblatt discusses the challenges of active management, including agency problems and behavioral biases.
- He cites studies showing that even top-performing managers often underperform in the short term, leading to investor churn.
- He argues that relying on past returns to select managers is unreliable and can lead to chasing returns.
7. Do-It-Yourself Investing and the Magic Formula:
- Greenblatt encourages investors to take a do-it-yourself approach, using his "Magic Formula" as a starting point.
- He describes his "Formula Investing" program, which offered investors the option to choose stocks from a pre-approved list or have them automatically selected.
- He highlights the results of the program, showing that automatic selection outperformed manual selection, demonstrating the potential pitfalls of investor discretion.
8. "You Can Be a Stock Market Genius" and Finding One-Foot Hurdles:
- Greenblatt discusses his book "You Can Be a Stock Market Genius," which explores "country auctions and yard sales" of the investment world.
- He suggests looking for undervalued opportunities in areas like spin-offs, bankruptcies, and small-cap stocks.
- He acknowledges that this approach requires significant time and effort, but can yield high returns.
9. Current Market Valuation and Value Areas:
- Greenblatt shares his assessment of the current market valuation, stating that the S&P 500 is currently in the 17th percentile towards expensive over the last 25 years.
- He notes that historically, similar valuation levels have been followed by positive returns, but emphasizes that this is not a prediction.
- He suggests that value areas exist within the market, but that investors need to be patient and discerning.
10. The Evolution of Greenblatt's Investment Strategy:
- Greenblatt discusses his early investment strategy, which focused on highly concentrated portfolios of undervalued companies.
- He acknowledges the high volatility and potential for large losses associated with this approach.
- He explains his shift towards a more diversified long-short strategy, which aims to be right on average over time.
11. The Impact of Passive Investing and Short-Term Dislocations:
- Greenblatt discusses the potential impact of passive investing on market efficiency and short-term dislocations.
- He argues that passive investing can create opportunities for value investors, as it can lead to mispricing of individual stocks.
- He emphasizes that short-term dislocations tend to be corrected over time, as the market eventually gets it right.
12. The Value Investors Club and the Importance of Learning:
- Greenblatt discusses the Value Investors Club, which he founded as a platform for value investors to share ideas and learn from each other.
- He highlights the club's merit-based membership process and the high quality of investment ideas shared within the community.
- He encourages investors to use the club as a learning tool, emphasizing the importance of understanding the fundamentals of valuation.
13. The Importance of Patience and Time Arbitrage:
- Greenblatt concludes by emphasizing the importance of patience and time arbitrage in investing.
- He argues that the increasing availability of data and shorter time horizons make patience even more valuable.
- He encourages investors to focus on long-term returns and avoid being swayed by short-term market fluctuations.
14. The Role of Multiples in Valuation:
- Greenblatt discusses the use of multiples, such as EV to EBITDA, in valuation.
- He acknowledges the challenges of finding accurate benchmarks and the need for careful analysis of individual companies.
- He expresses reluctance to create a standardized, open-source implementation of these metrics, citing the complexity of valuation and the need for in-depth analysis.