Joel Greenblatt
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Business and Investing Lessons From Joel Greenblatt

For a value investor, value is determined using methods that produce a fuzzy but very important benchmark, which is called “intrinsic value.”- Joel Greenblatt

“One of the greatest stock market writers and thinkers, Benjamin Graham, put it this way.  Imagine that you are partners in the ownership of a business with a crazy guy named Mr. Market. Mr. Market is subject to wild mood swings. Each day he offers to buy your share of the business or sell you his share of the business at a particular price. Mr. Market always leaves the decision completely to you, and every day you have three choices. You can sell your shares to Mr. Market at his stated price, you can buy Mr. Market’s shares at that same price, or you can do nothing.

Sometimes Mr. Market is in such a good mood that he names a price that is much higher than the true worth of the business. On those days, it would probably make sense for you to sell Mr. Market your share of the business. On other days, he is in such a poor mood that he names a very low price for the business.  On those days, you might want to take advantage of Mr. Market’s crazy offer to sell you shares at such a low price and to buy Mr. Market’s share of the business. If the price named by Mr. Market is neither very high nor extraordinarily low relative to the value of the business, you might very logically choose to do nothing.”

Joel Greenblatt makes a key point here: “Prices fluctuate more than values—so therein lies opportunity. Why do the prices fluctuate so widely when values can’t possibly? I will tell you the answer I have come up with: The answer is I don’t know and I don’t care. We could waste a lot of time about psychology but it always happens and it continues to happen. I just want to take advantage of it. We could sit there and figure it all out, but I like to keep it simple.  It happens; it continues to happen; the opportunities are there. 

I just want to take advantage of prices away from value.. If you do good valuation work and you are right, Mr. Market will pay you back.  In the short term, one to two years, the market is inefficient.  But in the long-term, the market has to get it right—it will pay you back in two to three years. Keep that in mind when you do your analysis. You don’t have to look at the next quarter, the next six months, if you do good valuation work—.. Mr. Market will pay you.”

“We believe that although stock prices often react to emotion over the short term, they generally trade toward fair value over the long term. Therefore, if we are good at identifying mispriced businesses (a share of stock represents a percentage ownership stake in a business), the market will agree with us…eventually.”

Value investing is not the only way to invest successfully.

There are other successful investing systems. For example, there is factor-based investing, which calls itself value investing, but isn’t Graham value investing. There is also activist investing, which can be combined with value investing. There are other investing systems like merger arbitrage. Benjamin Graham style value investing is not for everyone, but anyone who is an investor can benefit from at least understanding the system.

2. “Buying good businesses at bargain prices is the secret to making lots of money.” 

“Look down, not up, when making your initial investment decision. If you don’t lose money, most of the remaining alternatives are good ones.”

“We use EBIT–earnings before interest and taxes–and we compare that to enterprise value, which is the market value of a company’s stock plus the long-term debt that a company has. That adjusts for companies that have different ratios of leverage, different tax rates, all those things. But the concept is still the same. We want to get more earnings for the price we’re paying. That was sort of the principles that Benjamin Graham taught, meaning that cheap is good. If you buy cheap, you leave yourself a large margin of safety. Warren Buffett had a twist on that and said, ‘Gee, it’s nice to buy cheap things but I also like to buy good businesses.’

So if I could buy good businesses at a cheap price, it’s better than just cheap… We rank all companies based on their return on capital and we also rank all companies based on how cheaply we can buy them relative to their earnings. The more earnings, the better. Then we combine those rankings. And the companies that have the best combination of that ranking go to the top. So we’re not looking for the cheapest company. We’re not looking for the highest return-on-capital company. We’re looking for the companies that have the best combinations of those two attributes.”

Charlie Munger convinced Warren Buffett that quality (a good business) when combined with a bargain price was even better than just a business bought at a bargain price.

3. “Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

“Most people don’t (and shouldn’t) invest by buying stocks and holding them for only one month. Besides the huge amount of time, transaction costs, and tax expenses involved, this is essentially a trading strategy, not really a practical long-term investment strategy.”

The third bedrock principle of Ben Graham value investing system is that a security is an ownership interest in an actual business rather than a piece of paper to be traded based on person’s view about the views of other people, about the views of other people [repeat]. To value a stock, a value investor must understand the underlying business. This process involves understanding the fundamentals of the business and doing some relatively simple math related to the performance of the business.

Warren Buffett once described the stock market as a “drunken psycho.”

The financier Bernard Baruch similarly said once that “the main purpose of the stock market was to make fools of as many people as possible.”

4. “Periods of underperformance [make Graham Value Investing] difficult – and, for some professionals, impractical to implement.” 

 Seth Klarman, who is one of the very best value investors, writes: “Short–term underperformance doesn’t trouble us; indeed, because it is the price that must sometimes be paid for longer-term outperformance.”

Bruce Berkowitz said once about Berkshire Hathaway: “That is the secret sauce: permanent capital.

5. “Companies that achieve a high return on capital are likely to have a special advantage of some kind. That special advantage keeps competitors from destroying the ability to earn above-average profits.”

A moat is something that puts limits on that supply and therefore makes a business more valuable. Moats, like people, come in all shapes and sizes. Some moats are strong and some moats are weak.  Some moats protect things that are very profitable and some don’t.

Charlie Munger puts it this way: “Warren and I only look at industries and companies which we have a core competency in. Every person has to do the same thing. You have a limited amount of time and talent, and you have to allocate it smartly.”

6. “Remember, it’s the quality of your ideas not the quantity that will result in the big money.”

Michael Mauboussin writes: “being right frequently is not necessarily consistent with an investment portfolio that outperforms its benchmark…

The best investors who “know what they are doing” understand that investing decisions should be made based on an opportunity-cost analysis.

Charlie Munger has his own take on this same idea: “Everything is based on opportunity costs.

We have high opportunity costs. We always have something we like and can buy more of, so that’s what we compare everything to.”

If you are investing your own money and have the patience, concentration can work better. He now more focused on being “right on average” for outside investors instead of concentrated investing in about eight stocks.

Value investors are patient and yet aggressive, ready to act quickly whenever the opportunity is presented. Most of the time the value investor does nothing but read, think, and research businesses and industries. Actual buying and selling of securities and other assets happens rarely. Warren Buffett has a few thoughts on this point which are  set out below:
  • “You do things when the opportunities come along. I’ve had periods in my life when I’ve had a bundle of ideas come along, and I’ve had long dry spells. If I get an idea next week, I’ll do something. If not, I won’t do a damn thing.”

“I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.”

“The stock market is a no-called-strike game. You don’t have to swing at everything–you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, ‘Swing, you bum!’”

  • “One of the ironies of the stock market is the emphasis on activity. Brokers, using terms such as`marketability’ and `liquidity,” sing the praises of companies with high share turnover… but investors should understand that what is good for the croupier is not good for the customer. A hyperactive stock market is the pick pocket of enterprise.”

“If you are going to be a very concentrated investor, you should not use leverage. You can’t leverage because you need to live through the downturns and that is incredibly important.”

Being a successful value investor requires that you have staying power. When you use financial leverage your mistakes are as just as magnified as your successes, and those mistakes can be big enough to make you a non-investor since you may have no longer have funds to invest.

(a). Charlie Munger: “I’ve seen more people fail because of liquor and leverage – leverage being borrowed money.”

(b). James Montier: “Leverage can’t ever turn a bad investment good, but it can turn a good investment bad.  When you are leveraged you can run into volatility, that impairs your ability to stay in an investment which can result in a permanent loss of capital.”

(c). Howard Marks: “Leverage magnifies outcomes, but doesn’t add value.”

Charlie Munger points out: “You can argue that if you’re not willing to react with equanimity to a market price decline of fifty percent two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result that you’re going to get.

The best way to acquire good judgment so that you don’t panic is to read widely so you are prepared for this sort of result.

 

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