Joel Greenblatt, Master of Value Investing and Inventor of Magic Formula: Common sense of value

    If you're a fan of value investors, Joel Greenblatt's name is familiar. He is a well-known value investor, with an annualized return of 50%(before fees) for 10 years, making him a target for value investors to emulate. His book Stock Genius: Discovering the Secret Hidden Place of Stock Market Profits has convinced many people that they too can be good investors. Many investors will also use his invention of the "magic formula" to carry out stock selection. He is also a professor at Colombia University's business school, teaching investment courses that students flock to. Some of the best students in the class received his investment. He was also the founder of the New York Value Club, which discovered a number of stock pickers. This is the latest interview for Value Allocator. Because the subject is Greenblatt, we can't wait to organize his interview into Chinese as soon as possible for readers.

Main points

   Asset management is a difficult long-term business model. Although Greenblatt had made amazing returns for his clients over a decade and had delighted them, Greenblatt decided to return all outside investors 'money in 2005. As he describes it, managing client money in a centralized and largely retractive style is virtually impossible. Everyone likes high returns in the open market, but few people can stand the pain of achieving high returns.

   Fundamentals of value. Value investors assume that prices eventually return to intrinsic value. Greenblatt argues that the reason behind this hypothesis is causation, while the root cause of trend investing is correlation.

   Patience. The advantage of individual investors is time. Institutional funding is becoming more short-term, whereas individuals can wait longer.

Part 1 The Legendary Investment Life

   For such a master investor, we can't help wondering if he was gifted from an early age, or if there was some rare opportunity for him to embark on a successful investment path. Let's start with how Greenblatt began his investment career.

   Greenblatt grew up interested in how to do business. Growing up in a shoemaker's family, business was often the topic of dinner discussion as a child. Naturally, Greenblatt chose Wharton, a school known for its business studies, when he went to college. Although interested in business, his ambition at the time was to become a lawyer. This is one of the preferred career directions for many American Jewish families. So after graduation, Greenblatt went to Stanford University to study law.

   However, an article he read in Forbes magazine in college haunted Greenblatt. This is an introductory book. Graham and his stock picking formula. The prevailing theory in universities at the time was the efficient market hypothesis, which implied that markets could not be defeated. Greenblatt suffered from the fact that what he had learned in school could not explain the various stock market news he read in the newspapers every day. This real-time news made Greenblatt realize that stock prices are wild most of the time. Reading Graham's article lit Greenblatt's heart like a bolt of lightning in a calm sky. He fully agreed with Graham's philosophy that because people are emotional, they can often buy bargains in the market, and investors can keep buying at low prices. So he began to read voraciously about Graham and learned about Buffett.

   He and a few like-minded friends began sifting through stocks using Graham's method. Although it was still an early age of computing, Greenblatt and his friends developed a program that ran Graham's formula on computers and found a stock that was below liquidation value. With this program, Greenblatt raised $250,000 from his father's friends and began managing the money. This was his first experience with asset management. During his first year of law at Stanford, Greenblatt continued to run the small foundation, making a lot of money picking up cigarette butts.

   During this time, he became more certain that his ambition was not law, so he dropped out of law school and went to Wall Street, landing an internship as an options trader at Bear Stearns. While options trading is fun, Greenblatt doesn't plan to make it a long-term career. More entrepreneurial, he joined a friend's newly opened fund company after his internship and became the only analyst under the company's three partners to carry out risk arbitrage investments.

   Risk arbitrage, however, is fundamentally different from the Graham philosophy that Greenblatt shares in his bones. Value investing advocates not losing too much money if you fail, but making a lot of money if you succeed. Risk arbitrage, on the other hand, is where you lose $15 if you fail, but make $1 or 75 cents if you succeed. Of course, it takes a short time for risk arbitrage to make this profit, so annualized returns are still high. But the costs of failure in this way do not fit Greenblatt's philosophy. Soon, he turned to other deals that seemed odd at the time. These deals, which were odd and complicated and rarely noticed, fascinated him and paid him well.

   After three years at the firm, Greenblatt decided to go it alone and secured the services of then-renowned M & A financier Mike Mike Milken's $5 million investment. For someone like Milken, who negotiated twenty deals a day, a $5 million investment was a piece of cake. However, this deal is about Greenblatt's life. He has set his own bottom line and stuck to it. Milken ended up offering him twice what he wanted. Even so, Greenblatt ended up getting only the price he originally wanted, which was the money he needed to make sure he ran according to his philosophy.

Part II: Early Investment Career after Foundation

   One of the most curious things about Greenblatt's early investments is how he managed to annualize returns of around 50% a decade ago. In the interview, he disclosed that the first thing to do was to keep it small, and after five years of operation, he returned 50% of his investors 'money because it grew too fast. Concentration followed, with six to eight investments accounting for 80% of his portfolio at the time. Opportunities for a particular risk-return mismatch in the market are unusually rare. Often after looking at 70-100 opportunities, only 6-8 opportunities giving unusual risk-reward ratios are found. Greenblatt didn't want to reap the rewards of taking risks, but rather wanted to make money because he did more homework than others and found opportunities that went unnoticed. That's why there aren't many opportunities. Finally, he modestly acknowledged the importance of luck in his performance.

   What about how to assign weights to investments in a portfolio? Greenblatt's secret is to look down, not up. Often, the portfolio's largest positions are not the best companies he chooses, nor the investments he thinks will make the most money. Weight allocation measures how much money you lose on this investment. If the investment doesn't cost you a lot of money, you can take a bigger position. How do you define loss? Greenblatt's approach is to wait one to two years without leverage to lose money. In short, he weighed his positions by how much risk he was taking on his assets. So the ideal investment for greenblatt to take a large position is a good business that generates cash over and over, plus a little upside, not companies that appear to generate 10 times earnings.

   Greenblatt used an interesting metaphor to describe his criteria for selecting investment targets. His relatives often participated in spontaneous auctions organized in the countryside. When confronted with a favorite painting, relatives often ask questions other than,"Will this painter be the next Picasso?”It's,"Did this artist's painting sell for two or three times as much at a recent official auction?"”The skills required to answer these two questions are completely different. Greenblatt thinks his stock picking method is actually very simple, just doing more homework than others. If you can find a painting cheaper than the one recently auctioned and buy it in advance, one day others will realize the value of the low-priced work. And not many people will participate in the work of mining low-cost works, only a very small number of people will compete with you. Greenblatt's accumulated ability was to know where to find bargains.

   Greenblatt's early investment career was not smooth sailing and there were risky moments. In 1986, he was involved in several M & A financing transactions. It seemed that the companies he invested in were different, but he finally realized that he was betting on the same thing, that is, whether the merger financing would eventually be achieved. None of the M & A financing he invested in was finalised. These transactions cost him a lot of money. Fortunately, Greenblatt, who originally made 80% of his gains that year, ended up making 30% of his gains that year because of the losses on these mergers and acquisitions. It was a painful process that taught Greenblatt to be conservative. Then in 1987, when he sensed that the market was going badly, he quickly liquidated a large number of positions. It was also the only time in his career that he had done the right general direction timing. After the crash of 1987, he still made a 30% return that year. Over the same period, funds that used to follow his strategy suffered big losses. This taught Greenblatt to think about whether he would want to hold such a portfolio if the world were to end.

   After 10 years of running a well-known fund, Greenblatt reaped returns of around 50% on fees annualized, but he returned all outside investors 'money. This is not because of poor investment or investor criticism, but because of the short-term volatility of the fund's performance caused by the pressure on Greenblatt. Greenblatt had relatives and friends invest in his fund for two years, but suffered a 17% drop six months after they invested. It made him so sad that he wanted to kill himself. He said he loved investing so much that he wanted to enjoy every step of the way and didn't want to lose the joy of doing it because of the pressure of managing other people's money.

   In the evolution of investing, Greenblatt, like many value investors, has gone from Graham to Buffett. Early on, he emphasized absolute margins of safety, as Graham did. Buffett showed him how good companies enhance margins of safety. If you buy a good company, the margin of safety increases, and if you buy a bad company, its margin of safety decreases.

Part III becomes an investment bestseller author

   When it comes to Greenblatt, I have to mention his book Stock Market Genius: Discover the secret hiding place of stock market profits. More people know that he started with this pamphlet. Besides investing, he is also keen on writing. He himself has benefited greatly from Buffett and Graham's books, and hopes to share his investment experience with more people through writing. The urge to write intensified after he began teaching at Colombia University in 1996. In this book, he faithfully records the stories of his investments and what he was thinking at the time. He calls them "war stories", which shows how dangerous they are. For example, he wrote about a Florida theme park merger investment, one of his earliest. After buying, the subject company had problems such as crocodiles found in ponds. When he recalls these stories, he still hopes that people learn them as stories, not as investors.

   Despite the success of Stock Genius, Greenblatt found that reading the book required expertise that ordinary people could not understand. In order for ordinary people to benefit from his investment philosophy, he immediately wrote a second book « Stock Market Earnings: Booklet to beat the market », so that ordinary people can understand the basic concepts and methods of investment stock selection. In this book, he introduces people to the stock selection "magic formula" he developed.

   Greenblatt's other book,"The Big Secret of the Small Investor," hopes to further educate ordinary people about investing. Greenblatt argues that the advantage of individual investors over large institutions is patience. The root cause is the agent problem. Even the most long-term investors, such as university endowments, go through layers of agents before reaching the fund manager. Agents are often asked to beat a benchmark, causing them to fail over the long term. Individual investors, on the other hand, can understand what they want to invest in very well, not pay attention to short-term ups and downs or their own performance, but look at investments in the longer term. So individual investors actually have a longer-term perspective.

Part 4: A New Strategy: Fundamental Investing Like Quantification

   Greenblatt has always been a devoted Graham disciple. He tried new ways to test the effectiveness of undervaluation strategies, such as using programs to find companies that are both good and cheap. He hired software engineers who didn't know how to invest to help him write these programs. The companies identified by this criterion were found to be of excellent quality.

   Using programs to help pick stocks seems like a very labor-saving way. When Greenblatt found this method to be very effective, he continued to invest in refining the program and putting it into practice. Further research has found that the more diversified the portfolio, the better it works, especially when leveraged and invested through both long and short positions. With greater fragmentation, more funds can be accommodated. So Greenblatt broke with the old idea of not taking outside money and began to accept outside investment. This was a completely different approach from the concentrated shareholding he had previously preferred.

   Investing in this way resembles the current fashion for fundamental quantitative investing. However, Greenblatt argues that the fundamental difference between the two lies in different assumptions. Greenblatt's hypothesis is that (1) if the valuation is correct, the market will agree with it some day, perhaps in a week or two or a year or two;(2) Stocks represent ownership of a company, so invest like a private equity firm. What matters here is causation, the reasons behind the cash flow generated by the company, rather than correlations between data. What Greenblatt's analysts do is comb through the company's statements to understand what's driving cash flow, and what's true about cash flow, to see if the company is undervalued. Buying into these companies requires buying whole companies like private equity firms do. In positions, you need to weigh other risk indicators, company size, and liquidity.

   And once outside investment was accepted, Greenblatt felt obliged to devote all his energy to it. So he has switched all his investments to this style.

Part V: The Creation of Value Clubs

    Greenblatt is also credited with founding the New York Values Club. Back in 1999, when the Internet was still a new thing, Greenblatt came up with the idea of creating value clubs on the Internet, where people who didn't know each other discussed investment ideas online. Before that, investors were keen on the stock section of yahoo's discussion room. However, in Greenblatt's view, Yahoo's content is spotty. But Yahoo's stock board did give Greenblatt the idea for a value-club website. He used to feel lonely, thinking he was the only one on Wall Street who saw some opportunity. But he found people in Yahoo's stock section who also saw and studied these opportunities, and there was a sense of empathy. So the Value Club website came into being.

   On the website, people can post their investment ideas. Greenblatt invites friends with good ideas into the club. He also invited the best students in his class to join the club. It was an extremely difficult organization to join, even worse than Harvard's low admission rate. It currently has more than 500 members and an admission rate of around 2-3%.

   Not everyone can join the club, but after publishing an investment idea on the Value Club, you can get a variety of feedback from many equally intelligent investors, thus making your investment idea more mature.

   Another unexpected result was that the Value Club became the hedge fund equivalent of Whampoa. Greenblatt identified a number of potential fund managers and gave them early stage investments. In the early days, Greenblatt would participate in incubating these funds and acquire some equity in them. Now, however, he prefers to invest only in these funds rather than in equity, because incubation funds take up too much energy. Greenblatt particularly preferred fund managers who closely followed his earlier style of buying six to 10 stocks.

   After successfully running the Value Club, Greenblatt also introduced the idea to cancer research. Eventually he found that the field was too specialized, with subtle changes leading to huge differences in results, so that the value club format did not fully apply. Nevertheless, he continued to reward good ideas discovered under the program.

Part 6: Focus on Fair Investors

   Greenblatt, who loves writing, is about to publish a new book. Amazingly, this time the theme is not only about investment, but also about social equity. Common Sense: An Investor's Guide to Fairness, Opportunity, and Growth.

   This book focuses on how to make education fairer. He believes that education is a long-term investment that really changes people, so he spends a lot of personal energy on it, which is where he hopes to create value for society. Greenblatt helped found public schools for low-income minorities in New York. Although the children in these schools come from low-income families whose mother tongue is largely non-English, their math and English scores beat those of New York's wealthiest school districts. In these schools, children with disabilities do better than able-bodied children, and children from non-native English speaking families do better in English than native English speaking families. Greenblatt saw in these children that any child can do very well with the right support. In his book, he further explores how to give appropriate support. He argues that in order for children from poor families to have more career opportunities, the current admission criteria need to be changed to skills that can be acquired by affordable education rather than simply requiring a college degree. It is the buyers of labor, the organizations that hire labor, that drive the change in admission criteria. Greenblatt argues that social recruiters need to be pushed to change their hiring requirements so that more poor children can meet them without essentially lowering admission standards.

   Greenblatt's story as an investor is legendary. From what he did, we can see that he is an upright man. Growing up in a Jewish family, he was always asking himself to do the right thing. Although everyone is not perfect, we should do everything with the initial intention of doing the right thing.

   He saw that under the influence of the Internet, people became more narrow, not more open. When communicating with people, people tend to have established judgments or decisions rather than open up to more ideas. Greenblatt, a keen discussant, advises against preconceived notions.

   Finally, he recommends that everyone enjoy each journey in the present moment. We can learn a lot from what we see and experience, and we need to enjoy each moment. He believes that the sooner you learn this, the happier you can be.