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Questions and Answers With Joel Greenblatt

February 28, 2011

gurufocus

362 followers
GuruFocus is pleased to announce that our readers can now ask questions to Prof. Joel Greenblatt!

This is the second time that Prof. Joel Greenblatt takes questions from GuruFocus users. You can find the complete transcript of the last Q&A session here.

According to the website of Formula Investing Funds, Joel Greenblatt is a member of the investment team at Gotham Asset Management and founded Gotham Capital, a private investment firm, in 1985. He is the former Chairman of the Board (1994-1995) and a former board member of Alliant Techsystems (1994- 2000), a NYSE-listed aerospace and defense contractor. Since 1996, he has been a professor on the adjunct faculty of Columbia Business School where he teaches "Value and Special Situation Investing." Mr. Greenblatt serves on the Investment Committees of the Board of Directors for the University of Pennsylvania and UJA Federation, and is a director of Pzena Investment Management, Inc. (NYSE:PZN), a global investment management firm. He holds a BS (1979), summa cum laude, and an MBA (1980) from the Wharton School of the University of Pennsylvania.

Joel Greenblatt’s accomplishment far exceeds what this bio describes. He achieved 50% average annual investment return from 1985 to 1995, when he returned all the money back to the external partners. He is also the author of two books You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits (1999) and The Little Book That Beats the Market (Little Books. Big Profits) (2005).

It is in the second book, He outlined a simple, beautiful, and effective investment philosophy called “Magic Formula Investing”, which attracted a large group of followers among value investors.

Read these articles to find out more about how Mr. Greenblatt invests



This is the third of our series of interviews with the best value investors of our time. Also please read our previous interviews:

To ask a question to Prof. Joel Greenblatt, please post your questions in the User Comments area below. We will collect and send to Prof. Joel Greenblatt.

About the author:

gurufocus
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.1/5 (25 votes)

Comments

avishek
Avishek - 3 years ago
How do you screen your ideas?

You talked about a guy who figured out a company with complicated capital structure in a yahoo blog which was your inspiration of value investor insight.Was that guy Michael Burry?

How do you calculate normalized earnings?

How do you put a correct multiple in a normalized earnings? Is ROIC a good guide for correct multiple?
valueradar
Valueradar - 3 years ago
Your new funds owns hundreds of stocks. But in your book "You can be a stock market genius" you wrote that you prefer a concentrated portfolio. How do you invest with your personal portfolio? Concentrated or diversified?

Another question: How did magic formula stocks do in the market crash of 2008?
csucag
Csucag - 3 years ago


As I mentioned in your last Q&A session with Gurufocus, in my opinion your two books on investing are the best out there. Can you give details on how your soon to be released book builds on your past writings?
csucag
Csucag - 3 years ago
Obviously you would reccomend that the Average Joe should purchase magic formula stocks but if you, yourself had a portfolio worth thousands rather than millions, where would you focus your research efforts? Would you for example focus (but not limit yourself to) on nano cap special situations (say<$50m)? A particular type of special situation?

Obviously the basic principles in You Can be a Stock Market Genius have not changed but if you were to rewrite it today would you change anything? Would you highlight any other type of special situations? Are spin-offs as rewarding and as prevalent as they were in the 80's and 90's?
csucag
Csucag - 3 years ago
Do you still invest in special situations or have your funds grown so significant you have decided to focus purely on quantative investing techniques such as investing in magic formula stocks?
jb85
Jb85 - 3 years ago
For the record (and to answer some of the questions that have been posted above)

2. (by valueradar)... Joel greenblatt said in an interview on CNBC that of the funds he runs now, around 80% of the $ are in magic formula type stocks.

also relates to question #5. by csucag
jb85
Jb85 - 3 years ago
and now for my question.

Are there any other specific filters you add to the MFI screen. I know that 1 year relative performance was a good screen in "What works on wall street". Any backtests showing what happens if you rank the MFI stocks from the filter and pick only the best relative peformance (or maybe as another filter, what happens when you select stocks with asset to equity ratio of over 50%, etc.)

also, considering that many investors have 401k or other tax deferred accounts (and considering that via places like folioinvesting.com, trading costs are close to 0% for portfolios over $100k), have you looked into backtests where the holding period was less than 1 year. I know Haugen traded on a monthly basis, and his returns were better when he rebalanced monthly as opposed to annually)
paulwallba
Paulwallba - 3 years ago


When applying the magic formula to a

Roth IRA account (assuming trading fees are negligible), have you thought about a different methodology for turnover frequency or would you treat them the same way as a taxable account?

Also, because you can't write off losses, would you be less inclined to pick a basket of 30 stocks, and more inclined to pick a smaller, more concentrated basket?

_
csucag
Csucag - 3 years ago


What do your favourite Value Investor Club ideas have that the other ideas don't have? What would you say are the main weaknesses of the ideas posted by Value Investor Club members? Whats the ratio of ideas posted on Value Investors Club that you use to those you don't?
batbeer2
Batbeer2 premium member - 3 years ago
Professor,

Thank you for taking our questions. Like some other notable investors, you choose to teach. Why ?
paulwallba
Paulwallba - 3 years ago
When you started Gotham Capital, did you invest in OTC markets or mostly nasdaq stocks?

Also, if you had average returns of 50% for the first 10 years of Gotham's existence and 40% returns over the next 10 years, at what rate did you actually compound over those 20 years?

How did you find stocks in the early years of your fund?

Applying your concentrated position size to diversifying, do you feel that an IRA should be even more diversified or less based on the fact that you can't write off losses? And, moreover, do you feel someone's returns in an IRA should typically exceed that of their taxable account?

Also, assuming you are looking for new up-and-coming managers to invest in (like you did with Michael Burry), what kind of track record would it take to get your attention (5 years, 10 years, 40%+, 50%+ avg. annual returns)?
infinitee00
Infinitee00 - 3 years ago
Thanks Prof. Greenblatt for agreeing to answer our questions.

If I understand correctly, the magic formula works really well for self-managed individual investors who are willing to hold their portfolios over longer periods of time( typically 1+ years) and not sell during market crashes or panics.

However when the magic formula is used for selecting a portfolio of stocks in a mutual fund, investors may decide to pull their money out of that fund during periods of under-performance or market crashes/panics. This may, in turn, lead to further losses as the fund manager is forced to sell his/her holdings in order to accommodate the redemptions and not have enough cash to invest when the market is especially attractive ( based on more stocks with lower PE ratios).

Do you envision this to be a problem in managing mutual funds employing quantitative techniques where back tested results may not have accounted for investor redemptions ? As a fund manager, how would you mitigate the effect of investor redemptions on the performance of a fund, assuming that for the fund to yield the benefits of the magic formula investing method, it needs to be fully invested for 1 year periods and hold very small amounts of cash?
rgosalia
Rgosalia - 3 years ago
It seems to me that doing a magic formula approach, if workable, can be a really good way for a value investor to invest in countries that are out of one's circle of competence for individual stock picking (due to differences in accounting convention, language barrier or level of disclosure).

In your opinion, can the magic formula approach work in emerging markets like India or China despite these limitations? What kind of challenges do you see to using this approach today to these markets?
menkovisser
Menkovisser premium member - 3 years ago
Professor Greenblatt,

I know value investors such as Mohnish Pabrai state there are only 2-3 variables that really determine the intrinsic value of a business in the first 10-20 minutes, the rest results in diminishing value of time. I know Wall Street analysts look at even 20-30 small items (margin compression, operating rates, syngergies, etc....)....can you state the key 2-3 variables that Pabrai might be talking about?
rob.will
Rob.will - 3 years ago
I second question 11.

Also, do you go through OTCBB and Pink Sheet stocks? If so is there more of a cheap(dirt cheap) cigar butt approach there?
csucag
Csucag - 3 years ago


Would you be willing to share a compelling, current investment you have made?
jonmonsea
Jonmonsea premium member - 3 years ago
What percentage of one's equity portfolio might one commit to following to Magic Formula, or a Magic Formula Mutual fund?

Do you ever invest in bonds?

What is your take on LEAPS for large cap value stocks currently? For a stock paying a 2% dividend, what percentage premium (as a range) on today's price with missed dividends added back in would you be willing to pay for a Jan 2013 call? For instance a Walmart or a Microsoft.
sull428
Sull428 - 3 years ago


Professor Greenblatt,

I am a big fan of your two books and have long been a value devotee. I am also a member of your ValueInvestorsClub.com and now working at a value-oriented hedge fund in Korea. I have noticed that you teach Value & Special Situations Investing at Columbia Business School. What do you think is the marginal benefit of someone like me to attend Columbia and your value investing classes at Columbia in improving myself as an investor? In other words, what is the general level of skill and experience of your students in the Applied Value Investing Program at Columbia? What should I devote my time on to become a better investor?
paolino
Paolino premium member - 3 years ago
Professor Greenblatt

are you planning ETFs based on the magic formula? or funds for non US domiciled investors?
jhodges72
Jhodges72 - 3 years ago
A very important question every value investor should know. Boxers or briefs?
WIBruin
WIBruin - 3 years ago
Would you mind reviewing your investment process for a non-special situation long investment?

Thanks.
mla
Mla - 3 years ago
Professor Greenblatt, since the publication of The Little Book That Beats The Market, are there any additional criteria you have considered or back-tested against the Magic Formula results?

Are there any red flags you would look for in eliminating MF stocks from consideration? For example, what if a company's earnings appear highly unstable?

Thank you,

Maurice

travisgallatin
Travisgallatin - 3 years ago


Joel Greenblatt:

There have been plenty of studies that have shown that ranking stocks using earnings yield will out perform the market but what about the other variable in your Magic Formula? Have there been any studies that have show how only ranking companies by return on capital would do? Also, the Magic Formula doesn't appear to limit the amount of stocks from one particular industry that are displayed. Since historical info is used could you conceiveable end up with a lot of companies from one industry out of a list of the top 30 that are showing good historical results but would have their value permanently lowered by a change that has already been put into effect? For example the Gov stopping RAL loans for tax preparers or something like that.
toomuch
Toomuch - 3 years ago
Prof have degrees, maybe a BS or even a BA. Not this guy... my bad, solve a simple difeq? nope. I can't believe ya'll paid for this, embarassing. Michael Barry, now there is a smart man.
cvalue
Cvalue - 3 years ago
Mr. Greenblatt,

Return on invested capital is mean reverting, meaning it will on average decrease over time in the case of high ROIC. Could inclusion of this factor in the MFI therefore actually diminish rather than improve MFI returns?
jhodges72
Jhodges72 - 3 years ago
Wow!!! Someone gave me a 1 star ranking. Guess "someone" doesn't have a sense of humor. That's what I love about the internet. LOL.
jhodges72
Jhodges72 - 3 years ago
Hey Joel Greenblatt, what, exactly, do you love about the internet? There's a good question. Does Warren Buffett use the internet to make decisions? LOL. 1 star that biotch.
Hester1
Hester1 - 3 years ago


Before I ask my question I would just like to second question number 9. I would love to hear his answer to this as I think it would be good insight into how a great investor thinks and what he looks for.

Joel,

Recently the small and micro cap MF screens have been churning up multitudes of Chinese RTO stocks. Many, if not most, of these are blatant frauds. I realize that you may not focus much on the microcap area (due to your portfolio size), but have you thought about any techniques, quantitive or otherwise, to eliminate these and other potentially fraudulant companies where you can't trust the numbers?

Thank you for your time.
1234
1234 - 3 years ago
Professor Greenblatt,

In chapter seven of your first book you list an assortment of publications that one can navigate for investment ideas. Several years ago Warren Buffett indicated that if he was limited to one publication, he would opt for the Wall Street Journal. I believe he has since altered his choice to the New York Times. In 2007, Michael Price implied that the Wall Street Journal's quality had diminished in comparison to the past. Given that things change over time, would you please share your present thoughts pertaining to what you expressed in "You Can Be A Stock Market Genius". In 1997 you wrote, "You don't have to read anything other than the Wall Street Journal, though you can find new ideas almost anywhere in the business press. Particularly good newspapers for scouting out new ideas include the New York Times, Barron's, and Investor's Business Daily. There's also a list of well-known business magazines to choose from. I've found Forbes and Smart Money to be the best sources of good ideas. The next source of potential ideas is investment newsletters. My favorite is Outstanding Investor Digest. Another good investment letter is the Turnaround Letter." In addition, are there any industry specific publications that you read on a regular basis? In your book you mentioned American Banker and Footwear News. Are there any websites you utilize to mine for investment ideas? I believe I read that you were fond of Bloomberg and I assume that's true of your own sites (Magic Formula and Value Investors Club). Paul Sonkin revealed that he engages in "key word" alerts. Do you employ similar tactics? You also discussed prospecting investment ideas from the masters. Specifically, you mentioned Michael Price, Marty Whitman, and Richard Pzena. Whose 13Fs do you peruse? Whose 13Fs do you deem are of particular relevance to those that have small sums (under a quarter billion - to steal your phrase) to commit? (I've noticed that some of your proteges aren't required to file 13Fs).

Are you mindful of the market's overall expense level? If so, do you subscribe to Buffett's methodology, Shiller's P/E, any of Graham's pioneering thoughts, your own proprietary method, or something else? Could you please explain your process, as I find your writing to be even more concise and illuminating than that of Graham's and Buffett's indelible oeuvres.

Are there any books (aside from the ones listed in your first book, on your website, and in your course syllabus) investment related or otherwise, that you would recommend? As an admirer of your books and clarity of thought, I am eagerly anticipating the release of your newest book. Thank you for sharing your time and wisdom. It is very much appreciated.

cyrano
Cyrano premium member - 3 years ago
I was wondering if you felt that the U.S. financial dominance over the rest of the world could come to an end or at least slow down. Over the next 20 years, what do you expect U.S. stock investing returns will be compared to international stock investing returns? For example, how do you think your Professionally Managed U.S. account will perform relative to your Tax-Managed International account? Thanks for sharing your time with the community.
bernhardf
Bernhardf - 3 years ago
Can you give us some thoughts about valuing financial and utility stocks? Your developed "magic formula" is excluding this stocks. You said in an interview that you are working on a formula to value this kind of stocks with a formula too.
rateshop1
Rateshop1 - 3 years ago
Assuming one holds their magic formula stocks in their retirement accounts, should one still hold the stock for a full year or should they sell as soon as the stock drops off of the screen?
mla
Mla - 3 years ago
This was addressed in the book. You definitely should not sell the stock simply because it's dropped off the list.

http://www.magicdiligence.com/articles/magic-formula-tax-strategy-explained
eldra777
Eldra777 - 3 years ago


Hi Pro. Greenblatt

We (Investrcentre) have adopted your (Pro. Joel Greenblatt’s) approach for the Irish market.

The stock selection criteria are relevant to industrial stocks

but not financial stocks. Hence, the approach selects

industrial stocks only.

We first introduced the approach to

the Irish market in January 2008.

We have the record of returns for this approach over

the past sixteen years (i.e. back to 1995).



Using quantitative data alone we can determine ‘what to buy’and ‘when to sell’ particular stocks in the Irish market.


The approach provides a logical, yet easy-to-follow framework


for making investment decisions in the Irish market.

The methodology and long term performance results of a ‘value’


approach to investing in the Irish market over the


16-year period from the start of 1995 to end


December 2010. The approach selects stocks on a


yearly basis using a combination of (i) Returns on


Capital Employed and (ii) the Earnings Yield. The


approach does not select financial stocks.


Over the 16-year period, the approach delivered a


return of between 16-18% compound per annum


compared to returns of just under 6% for the ISEQ


Index over the same period. These returns include


dividends but exclude transaction costs and, for ease


of comparison, tax considerations. Including the


universe of all ISEQ stocks and selecting the Top 10


stocks using the criteria (outlined above) delivered a


compound per annum return of 18%. Excluding ISEQ


stocks with a market value of under €100 million,


which eliminates the smaller and often illiquid stocks,


reduced the return to 16% c.p.a. Both approaches


substantially eclipsed the ISEQ Index returns of 6%


c.p.a. over the same 16-year timeline.


This 16-year period (1995-2010) covered just about


every market phase an investor is likely to be hit with


and therefore is highly representative of the long


term. It covers the strong bull phase of 1995 to early


1998, the Asian crisis from mid to late 1998, the bubble


phase in global markets through 1999, the initial


bear market of 2000 - 2002, the recovery from 2003


to early 2007 and the severe bear market of 2007-09


as a consequence of the global banking crisis and the


property crash in Ireland.In essence, the approach picks non-financial stocks from the


ISEQ Index that offer the best combination of High Return


on Capital Employed (ROCE) and High Earnings Yield (EY).


A high ROCE is a sign of a profitable business while a high


EY is a sign of a business on offer at good value.


The combination of a high ROCE and high EY highlights


profitable companies on offer at good prices.


We (Investrcentre) update the stock selections each week.

Please leave your comment:


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