Guru Joel Greenblatt (Trades, Portfolio) is kind of unique in the sense that he understands quantitative investing really well but still believes doing old-school analysis adds value to that process. He's a perfect guest for a Google Talk on investing and I was delighted to see he made an appearence there.
These talks are very long so for your convenience I'll share my notes.
I'm assuming most Gurufocus readers are well acquainted with his books; You Can Be A Stock Market Genius, The Little Book That Still Beats The Market and The Big Secret.
When I started investing in all earnest Greenblatt had sort of gone of the map. Or at least that's how it looked to me. He didn't manage outside money anymore, which he does now, and he didn't do appearances or show up in the press much if ever. Now he's running outside money again he's showing up and it's great to see the guy behind one of my top 5 investment book of all time picks and the founder of the Value Investor Club.
I came away from this talk thinking Greenblatt is really genuinely interested in teaching about investing and improving the investment results of average Americans. I've been wondering why he chose the magic formula which underperforms a simpler quantitative strategy of buying the stocks with the lowest EV/EBIT ratios.
It started to click when, halfway the Google Talk, he remarks; the best strategy is the one you can stick to. Perhaps the Magic Formula represented that sweet spot to him. The EV/EBIT approach involves holding some really icky companies through years of underperformance. At least with the Magic Formula you can tell yourself you own some quality companies.
Notes:
-Greenblatt doesn’t use the Momentum factor (based on trailing > 1 year price action) because he isn’t convinced it won’t become a crowded trade. It has been widely proven to work by academics and he doesn't dispute it does. But he doesn't view it as actually hard to implement contrary to value investing which IS hard to implement due to the long stretches of underperformance.
-Time horizons are getting shorter. Greenblatt is playing time arbitrage. Which means being patient. He doesn’t compete with real arbitrageurs who jump on the slightest value discrepancy.
-99% of the stocks he buys go down further. Almost never buys at the bottom tick.
-Active managers suffer from biases. It's hard to invest other people's money. You don't like reporting bad numbers for some time. It's the same principle as why referees favor home teams. They don’t like getting booed.
-One story from The Big Secret about a top mutual fund at the time it came out. This fund had a 10 year track record at the time of realizing an 18% annual return. The market was flat over this time period so the performance was truly remarkable. Investors however jumped in after it had outperformed and left it after bad performance. The investors in the fund managed to turn a 18% per year outperformance into a 11% per year underperformance.
-Wrote up the first study they did and that worked really well for the Magic Formula.
-When you take simple formula’s: “adding your 2 cents may cost you a lot” (Morningstar article) This is a very interesting point. Greenblatt talks about how simple quantitative investing can outperform very strongly but if investors start to meddle and try to "improve" on the strategies they often ruin them. Ironically Greenblatt did the same thing with the magic formula but it's an important point nonetheless.
-The best strategy for you is not just the best strategy but the best strategy you can stick with.
-They closed a 5 star rated Morningstar fund to merge it with another because they thought the other was better. This is another example of how Greenblatt seems interested in helping people get investments results and definitely isn't a personal profit maximizer. Not necessarily anything wrong with going after profits but I'm just observing.
-Valuation of the S&P 500: Market, based on their research has been cheaper 83% of the time.
-Past results indicate on average it will go up 3-5% up over the next year.
-Past results indicate on average it will go up 8-10% over the next two years
-Buffett wants companies that deliver high returns on tangible capital.
-Explained his stellar returns in the past by quoting Buffett:
A fat wallet is the enemy of high investment returns.
They kept returning money not to get liquidity restrained.
Every 2-3 years using their strategy they lost 20% - 30% of their networth.
How they invested they couldn’t keep other people’s money. People essentially couldn’t take the pain.
-Bear case on Apple (AAPL, Financial) it is a hardware company and it will crash and burn like they all do.
-Bull case on Apple it is an ecosystem of products and people are locked in and will keep buying.
-Greenblatt thinks it is in between. He’s not sure which of the two it is but compared to the S&P 500 (SPY, Financial) it is cheap enough he feels there’s a margin of safety.
-ETFs can cause dislocations. If there is flows into ETFs that can cause dislocations. The market eventually gets it right.
-The indexers get it right for the wrong reasons.
-Joel thinks the market often gives you opportunities but these are very hard to take advantage of. Behavioural science
Author: isn't long or short any stocks mentioned.
