The aim of Joel Greenblatt (Trades, Portfolio)’s 1999 book, “You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits,” was to take readers off the beaten path so they could discover new investment opportunities.
In chapter two, he started with the basics, some fundamental ideas about investing his way (and his way was very successful, some 40% per year for the first 21 years Gotham Capital operated).
He began by telling us about an illicit visit to the Hollywood Dog Track when he was 15 years old. Convinced he had found “a sure-fire route to big greyhound riches,” he bet much of what he had on near-certainty. He was, he said, quite happy to take the money of the losers who bet against his favorite.
That youthful arrogance changed into respectful humility as his dog fell behind every other in the race and eventually came in last. While the stats showed his dog "Lucky" had outrun all its competitors in previous races, they were running a longer track this time. Greenblatt admitted his research failed to make a distinction between previous shorter races and this longer one. With a few mixed metaphors, this is how he summed up:
“On the bright side, in less than a minute I learned a valuable lesson. Without a basic level of knowledge and understanding, you can’t tell a great investment from a real dog. So before you start hunting in the stock market’s back alleys for hidden investment jewels, here are some basics that should help in the search.”
Here are his seven basics:
- Do your own work. Since you are looking for undiscovered bargains, you won’t have much help from analysts or other investors; you must go off on your own. If you do this correctly and well, you will earn above-average returns without taking on additional risk.
- Don’t trust any over 30. A reference to a popular book and saying in the youthful counter culture of the late 1960s and early 1970s.
- Don’t trust anyone 30 or younger. The joke and the point is that investors should trust no one, young or old, and especially not the people calling to try to sell them investment services or advice. It is saying once again, “Do you own homework.”
- Pick your spots. Be like Warren Buffett (Trades, Portfolio) and restrict your investments to your zone of knowledge and competence. You cannot watch all the countless events transpiring in the market, so pick one area and focus on it. Greenblatt added that having a concentrated portfolio is not as risky as some would have you believe—you may experience some increased volatility, but that will be offset by increased returns in the long term.
- Invest in other asset classes. Rather than diversifying too much in your portfolio of stocks, diversify by putting money into a bank account, a money-market fund, life insurance policies or real estate.
- Look down, don’t look up. Ignore the old chestnut that says you must make a trade-off between risk and reward. Instead, think about risk as the loss of your capital and try to avoid it with what Benjamin Graham called the margin of safety.
- There are many routes to investment success. Consider Buffett and Peter Lynch, two investors with different approaches, but both have been outstanding successes. Greenblatt wrote, “Simply because you’ll be looking for investments in out-of-the-way places doesn’t mean that you can’t or shouldn’t apply some of the wisdom gleaned from the winning methods of a Graham, Buffett, or Lynch.”
With those seven basic issues covered, the author began his introduction to the promised secret hiding places. He pointed out that stock market profits are all around us, and the underlying theme these opportunities have in common is change of some kind. He wrote, “Something out of the ordinary course of business is taking place”.
Such changes can include a broad number of corporate events, including spinoffs, mergers, restructurings, liquidations, asset sales and distributions. Such events can also trigger new securities that bring extraordinary new possibilities.
Many of us regret not buying into companies like Amazon AMZN and Apple AAPL early, but Greenblatt said we should not. There will be many more opportunities; the challenge is to determine which of them will be great. As he noted, finding the next Walmart WMT or McDonald’s MCD is going to be tough.
There are more failures than successes in such hunts, but you have an edge if you use your own experience and intuition. But only within the context of what you know and understand. That, of course, has been one of the great lessons of Buffett’s investing career.
Greenblatt pointed out a few drawbacks to investing in special corporate situations. The first is it involves quite a bit work (for which you should be well compensated). The second is that windows of opportunity are often short, potentially making your holding period short and thus, exposing you to tax disadvantages. Pick your spots and your situations.
Another drawback is you cannot take comfort in crowds, you must go your own way. And then there’s the hard reality faced by ultra-successful investors such as Buffett and Lynch: Trying to find places to invest billions of dollars at a time.
On that final point, Greenblatt offered these words of reassurance: “For your first quarter billion or so, though, it’s no problem. (Call me when you get there.)”
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
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