The CFA Society New York published a new video from the June 2019 Benjamin Graham conference where Richard Pzena (Trades, Portfolio) interviewed value investing legend Joel Greenblatt (Trades, Portfolio). The full video is embedded below, but I’ll summarize the critical content.
Discussion of current environment
They started by discussing the current environment that seems rather hostile to value. Spreads between cheap and expensive or value and growth are the widest ever. The Russell 1000 pure growth index outperformed the Russell 2000 value index by 100% over the last 10 years. Over the last six years, Russell pure value is up 60% and the Russell pure growth is up 180%.
Greenblatt on value versus growth
Growth is a part of valuation. The Russell and Morningstar define value by price-book value or price-sales. If you use the Russell or Morningstar definition, that has worked historically, and Greenblatt expects it will work in the future.
But Greenblatt isn’t particularly interested in whether the academic version of value works.
Stocks are ownership shares in a business. You value the business and if you like the price, you buy it. This strategy will never be out of favor.
There are other investing factors that worked. Momentum worked for the last 30 to 40 years. But Greenblatt doesn’t do it. If momentum stops working, you don’t know if it is cyclically out of favor or if it is a crowded trade.
Greenblatt likened momentum investing to real estate investing. “If I told you I’m going to buy the ones that went up the most last year, you would laugh at me,” he said.
Greenblatt likes to tell his students that if they do good valuation work, the market will agree with them. He just never tells them when that will be.
Greenblatt’s process
"People eat, breathe and extrapolate."
-Jim Grant
Greenblatt's definition of value is simple. Again, he went back to real estate. If you buy a house, you have to figure out whether you get a good deal.
Greenblatt does normalized earnings calculations and uses relative valuation often. He asks: What is the company worth historically, what is worth compared to similar companies, what it is worth in context of the market?
His strategy is simply to figure out what it is worth and pay a lot less. Greenblatt believes that if you bought companies purely on the traditional value attributes, you would do fairly well too. But this works better.
Why will or should value outperform
Valuation is the real gravity in markets. When people buy into a "growth at any price" mentality, that may work for some companies -- but not for all of them.
People get emotional, they get overenthusiastic, they are impatient and they are short-term-oriented. Greenblatt said he thinks they are currently overly enthusiastic about growth at any price. There are also huge agency problems at institutions.
He said he doesn’t know what will change things in the growth versus value dynamic but believed value will go back to outperforming over time.
If what he did would work every day, every week and every year, everyone would do it, he said. You get paid for your strong stomach.
What does his value strategy look like?
His strategy evolved from Ben Graham's classic buying cigar butts to buying good companies cheap. Where he ended up is investing in companies that earn high returns on tangible capital and that are cheap. If you don’t need a lot of capital, you don’t need a lot of debt to grow. Typically, they don’t have substantial debt. Greenblatt also likes companies that reinvest earnings at a good return.
Disclosure: No positions.
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