On Oct. 29, investorÂ Joel Greenblatt (Trades, Portfolio) appeared on Bloomberg TV. The guru is primarily known for "Magic Formula Investing" (combining value and quality metrics), but he's also the founder of Gotham Asset Management LLC, the author of multiple investment books and adjunct professor at the Columbia Business School.
Gotham runs a number of funds that are widely available:
Greenblatt believes we are in the 22nd percentile towards expensive. The market has been cheaper 78% of the time. It has been more expensive 22% of the time.
What has happened going forward based on their data?
The market, on average, did 6% in the subsequent year. The market did 10% to 12% (total) over the following subsequent two years. This is a subnormal return set. The market has gotten cheaper lately, but it is still not cheap.
What could happen from here?
The market could fall 18% to 20% tomorrow, but that doesn’t have to happen. Subnormal returns of 4% to 6% for three years would also put the market back on a normalized track, which actually doesn't sound so bad.
Greenblatt admits he doesn't know what will happen in the next few months.
The firm shorts stocks that are generally trading at 50 to 100 times earnings or even losing money. Think of them like FANG stocks. Gotham owns hundreds on the long side and hundreds on the short side. Historically, this is the world's worst investment strategy. Although it hasn't been of late, they continue to short the world's worst investment strategy.
Gotham values businesses based on cash flow like a private equity investor would. They concentrate on businesses generating 6% to 9% of free cash flow yield. This type of strategy will never go out of favor, according to Greenblatt.
He also believes the growth group (not necessarily the individual names) will come back to earth at some point. He doesn’t know what the catalyst will be and it could play out in a lot of different ways. The Russell 2000 is in the 94th percentile, for exampe. It has been more expensive only 6% of the time.
Currently, the top 10 holdings of the Gotham Absolute Return Fund are:
Intuit (INTU) is a new holding. The fund is taking away from Micron (MU, Financial) and adding to Esteee Lauder (EL, Financial), Kimerly-Clark (KMB, Financial), Cisco (CSCO, Financial), Amazon (AMZN, Financial), Medtronic (MDT, Financial) and Oracle (ORCL, Financial).
Disclosure: No positions.
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