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Rupert Hargreaves
Rupert Hargreaves
Articles (556)  | Author's Website |

Joel Greenblatt's Secret to Beating the Market

According to a Wall Street legend

May 21, 2018

Joel Greenblatt (Trades, Portfolio) has written several books on the subject of investing over the years, and he is a Wall Street legend. His books, "You Can Be a Stock Market Genius" and "The Little Book That Beats the Market," contain a wealth of invaluable information for investors on the topic of investing, and how you can improve your investment process by making a few simple changes to the way you think about the market.

Indeed, using the rules set out in these books, Greenblatt's firm, Gotham Capital, managed to achieve compound annual returns for investors of 20% over several decades, a rare in the rest of the hedge fund universe.

Greenblatt also taught a Special Situation Class at Columbia’s Graduate Business Program from 2002 through 2006 that covered the ins and outs of investing as well as how to make money from special situations and invest using value principles.

The transcript of this class is fascinating. Greenblatt used his time with students to explore different avenues of investing and what has helped him succeed. He brings in other highly regarded value investors to talk about their strategies.

The Greenblatt strategy

Greenblatt's style boils down to two factors, value and quality, which becomes clear throughout. One of the more interesting sections is a section of the discussions is titled "How to Beat the Market," a short, but a highly informative guide from this Wall Street legend on how to make the market work for you.

So, what is Greenblatt's secret? Well, according to the transcript, one of the best ways to beat the market is to focus on small-cap stocks. In the small-cap arena, companies tend to have less analyst coverage, and therefore it is easier to find mispriced opportunities with small caps.

There are also size constraints on investors acting in this market. When successful small-cap investors have made a fortune, they have to graduate on to large caps, so there's a high turnover of actors working in the sector, meaning of there is always an "opportunity to do original work."

Gotham also tends to be very concentrated with one "five to eight" securities according to Greenblatt's lecture. This level of concentration, even for the likes of Warren Buffett (Trades, Portfolio), is quite high and really only suitable for those investors who are willing to put in the legwork and do the research. Greenblatt believes that this is key. Knowing your companies, he says, removes the risks associated with the lack of diversification. Having a deep understanding of each opportunity are you involved in is much safer than broad diversification.

What's more, by running a concentrated portfolio, you only need to find "several ideas a year," meaning there's more time to focus on each opportunity and do other things that may potentially enhance your circle of competence.

These ideas are relatively simple and easy to understand. You do not need the highest IQ or best education in the world to be able to use a concentrated portfolio approach, or invest in small caps. However, you do need to be able to ignore the rest of the market, which is why Greenblatt believes most investors fail.

Simplicity is the core of Greenblatt's work. Rather than trying to put together complicated spreadsheets with forecasts of a company's potential, he recommends using a simple valuation process using several "basic concepts" such as a discount cash flow forecast, acquisition value calculation or relative value calculation. If one of these is hard to put together, he will move on to the next one.

Cash flow and return on assets are a priority. Once you've done the work, you need to stick to it and hold on for the long term. As I said above, it's not a complicated or complex process. Greenblatt believes in simplicity as the best way get results. Simplicity, concentration and a long-term perspective.

Beating the market is not difficult if you know how and you're willing to put in the hard work required to understand the business inside out. This part of the process is not complicated. It's just time-consuming, and so is the waiting for value to be realized. Unfortunately, it is these two steps investors find the hardest to follow through on.

Disclosure: The author owns no stock mentioned.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. Prior to his investing and writing career, Rupert was as a proprietary currency trader. Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


Rating: 4.7/5 (7 votes)

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Comments

Praveen Chawla
Praveen Chawla premium member - 2 months ago

Good write-up. Will it be possible to provide a link or a reference to the transcript?

stephenbaker
Stephenbaker - 2 months ago    Report SPAM

According to Gurufocus, Greenblatt's firm, Gotham Asset Management currently owns 929 stocks. Is this defined as concentration? Otherwise, why did he vary from his roots? Could it be that there is more money to be made in asset management than in stock selection?

snowballbuilder
Snowballbuilder - 2 months ago    Report SPAM

@stephenbaker i ve seen an interview on your topic on wealthtrack

https://wealthtrack.com/greenblatt-strategy-change/

That's an interesting interview really worth watching

greenblatt sayd that a well diversified portfolio is more fitted for listed/open fund so his funds now holds hundreds of stocks

but he added that

he still run his private partnership were he his focused 4/6 stocks he sayd that the return of the partnership are well higher than the funds but with lot more volatility and swings.

Best snow

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