Joel Greenblatt, the managing principal and cochief investment officer at Gotham Funds, thinks investors should think about buying stocks in the same manner they would buy a house.
Greenblatt has crushed markets for decades, and is currently trouncing 96% of his competitors.
His strategy adds a unique twist to the time-honored strategies of legendary investors Warren Buffett and Ben Graham.
Greenblatt defines the term “value investing” differently than most, and eschews a strict adherence to popular metrics such as price-to-book and price-to-sales ratios.
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It only takes a few minutes of chatting with legendary hedge fund manager Joel Greenblatt — the managing principal and cochief investment officer at Gotham Funds — to understand how much of an influence the likes of Warren Buffett and Benjamin Graham have had on his investment career.
It all started when Greenblatt stumbled upon an article in Forbes magazine delineating Benjamin Graham’s stock-picking formula when he was studying to become a lawyer.
“I was immediately smitten,” he said in an exclusive interview with Business Insider. “I thought everything that I read in the article made sense to me — a formula to pick stocks sounded really good to me as well.”
He continued: “From there I just started reading everything that Ben Graham wrote and eventually got to Buffett.”
The confluence of Buffett and Graham’s timeless, value-centered investment principles immediately resonated with Greenblatt. And in time, they’d serve as the foundation of his own similar strategy — one that’s been trouncing markets for decades, and more recently, crushing 96% of competitors.
The amalgamation that Greenblatt acquired is: buy it good (Buffett), and buy it cheap (Graham). However, Greenblatt differentiates himself by shorting companies with nose-bleed valuations as well. In this conversation, the focus will be on his buy criteria.
Greenblatt’s strategy is simple in theory, but without the right emotional or valuation skillset (something he puts an emphasis on), difficult in practice. It revolves around figuring out what a business is worth, paying a lot less than that valuation, and leaving a wide margin of safety.
He provided the following analogy to demonstrate his thinking:
“You’re buying a house. They’re asking $1,000,000 for it. Your job needs to be to figure out whether that’s a good deal. One thing you might think to yourself is ‘if I rented out that house — net of my expenses — how much would I be earning every year?'” he said. “If I can get $70,000 or $80,000 — in a 2% interest rate environment — on a $1,000,000 house, that might look pretty attractive and might help me justify the million-dollar purchase price.”
Redefining value investing
Greenblatt defines value investing differently than most. His eyes aren’t fixated on buying businesses with low price-to-book ratios or low price-to-sales ratios like most traditional value investors. His attention is on the cash flows he expects to receive from the business — and that’s made explicitly clear in his example.
The $70,000 or $80,000 that Greenblatt refers to …read more
Source:: Business Insider – Finance