Investor Joel Greenblatt is crushing 96% of peers by adding a unique twist to the famed strategies of Warren Buffett and Ben Graham. He shared with us his winning approach.
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. Click here for more BI Prime stories.
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 above is analogous to a company's cash flow. A crucial indicator that many investors look towards in order to forecast earnings growth (or lack thereof). In this case, Greenblatt's house would be earning 5% to 6% above the risk-free rate of return (2%) based on the provided metrics. The next step in Greenblatt's investment strategy is comparison. "Then you'd probably ask some other logical questions like: 'What are the other houses on the block going for? And the block next door? And the town next door? How relatively cheap is this house relative to other similar houses?'" he said. "And we do that too." The same holds true for stocks. "When we look at companies, we ask questions like: 'How cheap is this company relative to similar companies? How cheap is this business to all companies? How cheap is this business relative to historical prices?'" he said. "We use our measures of absolutely cheap on a free-cash-flow basis and relatively cheap, and all these different ways to zero-in on fair value." Juxtaposing the business under consideration to comparable businesses, different businesses, and the overall market gives Greenblatt a better sense of whether or not its stock is — you guessed it — a good value. That last bit is crucial to understanding Greenblatt's methodology and thinking. He views stocks as ownership shares of businesses, not a flashing ticker symbol. "No private equity firm who's valuing a business to buy the whole business looks at whether it's low price-to-book," he concluded. "They're looking at the cash flows they're going to receive from the business, and that's the way we look at valuing businesses as well." SEE ALSO: 'This is a really huge buy signal': Billionaire Bond King Jeffrey Gundlach lays out a juicy investment setup worth seizing — one that's only happened a handful of times in the last 100 years Join the conversation about this story » NOW WATCH: A big-money investor in juggernauts like Facebook and Netflix breaks down the '3rd wave' firms that are leading the next round of tech disruption
More like this (3)
Warren Buffett's Berkshire Hathaway has lost Bill Ackman as an investor. The hedge-fund manager revealed the...Warren Buffett's Berkshire Hathaway has lost Bill Ackman as an investor. The hedge-fund manager revealed the sale of his Pershing Square fund's $1 billion Berkshire stake in a conference call on Wednesday. Pershing sold Berkshire in the last few weeks to free up cash so it can capitalize if prices fall again, Ackman said on the call. The move is surprising as Ackman boosted his Berkshire holdings by more than a third in the first quarter. Visit Business Insider's homepage for more stories. Warren Buffett's Berkshire Hathaway has lost billionaire hedge-fund manager Bill Ackman as an investor. Ackman revealed the sale of his Pershing Square fund's $1 billion stake in Berkshire, and its exit from much smaller positions in Blackstone and Park Hotels & Resorts, in a conference call on Wednesday. Berkshire accounted for just over 15% of Pershing Square $6.6 billion stock portfolio at the end of March. Pershing Square sold its Berkshire stake in the last few weeks to free up cash so it can capitalize if juicy investing opportunities emerge, Ackman explained on the call, according to a transcript on Sentieo, a financial-research site. "Today, we have $10 billion of capital to invest, we can be much more nimble," he said, highlighting Pershing's smaller size relative to Berkshire. "And so our view was generally we should take advantage of that nimbleness, preserve some extra liquidity in the event that prices get more attractive again." Pershing Square confirmed the sale to Business Insider, but declined to comment further. Bloomberg first reported the news. Read More: Billionaire and legendary investor David Booth: Here's how to invest smartly right now so you come out of the pandemic with financial security Ryan Israel, a partner at Pershing, elaborated on the decision to dump Berkshire during the conference call. While Pershing's bosses expect Berkshire to be a "strong investment over the longer term," their view is that "the current environment means there may be more than typical opportunities for us to see very high-returning investments." Berkshire has showcased the quality of its subsidiaries and made strides towards boosting its profit margins relative to peers during the recent downturn, Israel continued. However, Buffett's company has bucked Pershing's expectations by not deploying its $137 billion in cash reserves to buy stocks and other securities, acquire companies, strike deals, and repurchase shares, he added. If Berkshire does put its cash to work in the short term, Israel argued, it will likely be during a period when Pershing also enjoys a choice of enticing investment options. Following the Berkshire sale, Pershing will be armed with enough cash to take advantage of them, and be able to move more nimbly than Berkshire due to its smaller size, he added. Read More: GOLDMAN SACHS: These are the 20 stocks hedge funds piled into most aggressively last quarter — and history suggests they're set for big gains Still, Ackman's exit from Berkshire is surprising. Pershing only invested in Berkshire last year, and boosted its stake in the company by more than a third to about 5.5 million shares in the first quarter. Those shares were valued at almost $1 billion at the end of March. Moreover, Ackman has repeatedly praised the famed investor and his business. "Berkshire Hathaway was built by Warren Buffett to withstand a global economic shock like this one," he wrote in Pershing's 2019 annual report. "We believe that Berkshire will emerge from this crisis as a more valuable enterprise," he added. Ackman famously turned $27 million into $2.6 billion by hedging his fund against the coronavirus sell-off, offsetting the damage to its equity portfolio. He used the windfall in March to boost Pershing's stakes in Berkshire as well as Hilton, Lowe's, and Burger King-parent Restaurant Brands, and to reinvest in Starbucks. Read More: A Wall Street chief strategist analyzes 4 recessions throughout history to explain why investors should still be buying stocks — even as the economy hurtles into depressionJoin the conversation about this story » NOW WATCH: Why Pikes Peak is the most dangerous racetrack in America
A value-investing expert explains why beaten-down stocks are the most appealing since the dot-com bubble — and shares 3 stocks he bought as the coronavirus crash created 'rare' opportunities
Tobias Carlisle, the founder and portfolio manager of The Acquirers Fund — a long/short deep-value exchange-traded...Tobias Carlisle, the founder and portfolio manager of The Acquirers Fund — a long/short deep-value exchange-traded fund — leans on historical data to make a compelling case for value-oriented investors going forward. Historically speaking, Carlisle says that "higher-than-average future returns" for value stocks follow periods of unusual discounts. Cliff Asness, the billionaire hedge-fund manager and founder of AQR Capital Management, echos Carlisle's view stating: "This is where long-term investors make their bones." Near the lows of the coronavirus-driven stock rout, Carlisle rebalanced his portfolio and scooped up shares of three companies. He details those trades below. Click here for more BI Prime stories. There's no denying that value-oriented investment strategies have hit a rough patch. "However it is measured, value is mired in an extended period of underperformance," said Tobias Carlisle, the founder and portfolio manager of The Acquirers Fund. "Depending on how it is measured, that underperformance begins in 2005 or 2014." Carlisle notes that value portfolios structured around price-to-earnings ceased to outperform glamour stocks — widely held and popularized stocks with perceived strong growth potential — in 2005. Then, in 2014, he points out that value portfolios assembled around price-to-cash flow value started to lose their luster against their glamourous counterpart. Carlisle provided the following charts showing the underperformance of both portfolios utilizing data aggregated by Nobel laureate Eugene Fama and his colleague Kenneth French: And here's price-to-cash flow value: Carlisle offers a straightforward explanation. "The reason value has underperformed recently is because cheap stocks have gotten cheaper," he said. "It's no simpler or complex than that. Prices have fallen relative to fundamentals." Experts across Wall Street have also long surmised that historically easy monetary conditions, as dictated by the Federal Reserve, have continuously encouraged speculative investing behavior. That means traders have kept piling into so-called growth names — or proven winners — even as they've blown past historical valuation thresholds. Cliff Asness, the billionaire hedge-fund manager and founder of AQR Capital Management agrees with that prognosis. "Investors are simply paying way more than usual for the stocks they love versus the ones they hate (and measured using our most realistic implementation this is the clear maximum they've ever paid) and doing it it in a highly diversified way up and down the cross-section of stocks," he said in a recent blog post. Those elements have combined to make sticking with a traditional value-investing especially difficult. After all, how many market participants have the patience to sit through years of underperformance without making a change? How many want to plow into a strategy that's been trounced? How many can resist the hefty returns offered by mega-cap tech titans? Carlisle, for one. He's not sweating value's prolonged downturn. He's instead focused on the opportunity at hand — one that looks past recent weakness. "Historically, the presence of unusually cheap value stocks has preceded higher-than-average future returns for long-only value portfolios," he said. "Opportunities like this are rare. The last time the opportunity looked similar to now was at the 2000 dot-com peak. Following on from that peak, value had an unusually strong run from 2000 to 2007." He added: "The best returns to value strategies — above-average returns — have all emerged from the times value has underperformed. Now is such a time." Carlisle's sanguine view is echoed by Asness again. "We think the medium-term odds are now, rather dramatically, on the side of value, with no 'this time is different' explanation we can find (and we've tested a lot of them!) holding a drop of water and no other period in the 50+ year history matching today," said Asness He added: "This is where long-term investors make their bones." Although both investors have recognized the value opportunity as a fairly obvious one, Carlisle is quick to warn that things can always get worse before they get better. Patience is key. "The caveat is the 2000 valuations and spread aren't necessarily the end point," he said. "There's no reason value can't get cheaper and the spread widen. If that happens, the opportunity continues to improve, but it will underperform while it does so." 3 timely pickups In the midst of the coronavirus-induced market panic, Carlisle was busy rebalancing into names that had been decimated in the fray. Below are three stocks he scooped up, along with his reasoning behind the purchases. All quotes below are attributable to Carlisle. 1. Berkshire Hathaway (BRK-B) "Warren Buffett's diversified conglomerate trades as cheaply today as it did at the bottom in 2009, and cheaper than it did in 2000. Buffett has been selling some of Berkshire's holdings recently, but the company has a bullet-proof balance sheet and massive cash flows. It also happens to be run by the greatest investor alive." 2. Markel (MKL) "Markel is a mini-Berkshire Hathaway run by a Buffett-like value investor and operator in Tom Gayner. Book value has compounded at 35 percent a year over the last decade. With a market cap below $12 billion, it is 30 times smaller than Berkshire, so should be able to take advantage of many more opportunities." 3. Charles Schwab (SCHW) "One of the largest, and most recognizable names in broking and asset management with a best-in-class management team. Schwab has a strong balance sheet, solid fundamentals, and top-line growth above 10 percent yearly for the last three years. It's cheaper than average for better than average."SEE ALSO: John Fedro quit his job and got involved in real estate with barely any money. He breaks down his low-cost approach to mobile-home investing, which allows him to live comfortably on passive income. Join the conversation about this story » NOW WATCH: Why electric planes haven't taken off yet
'Buffett needs to listen to Buffett again': Investor was wrong to recommend tech-heavy S&P 500, Berkshire Hathaway shareholder says
Warren Buffett recommended the S&P 500 several times at Berkshire Hathaway's shareholder meeting this month. The...Warren Buffett recommended the S&P 500 several times at Berkshire Hathaway's shareholder meeting this month. The famed investor effectively advised investors to back the "big tech" companies that make up a large chunk of the index, Tony Scherrer of Smead Capital Management said in a blog post. However, Buffett warned against "gruesome" businesses that grow quickly, require lots of capital, and generate minimal profits in his 2007 shareholder letter. "It looks to us like Buffett needs to listen to Buffett again," Scherrer said. "He is forgetting what gruesome looks like by fawning on the Index and some 'obvious' winners of today." Visit Business Insider's homepage for more stories. Warren Buffett's advice to invest in the S&P 500 clashes with his past warnings against "gruesome" businesses, Tony Scherrer, director of research and portfolio manager at Smead Capital Management, a Berkshire Hathaway shareholder, said in a company blog post on Tuesday. "I recommend the S&P 500 to people," Buffett said at Berkshire's shareholder meeting this month, according to a transcript on Sentieo, a financial-research site. The famed investor also described the benchmark index as "the best thing" for most people, and argued that telling them to park the majority of their wealth in index funds was "better advice" than most investment advisors offer. Read more: 10 big-money investors each share the single market risk they think traders are overlooking right now However, Scherrer pointed out that five companies account for more than 20% of the S&P 500's weighting: Apple, Amazon, Alphabet, Facebook, and Microsoft. As a result, Buffett effectively endorsed those large technology companies, he said. "He recently emphasized indexing and didn't shy folks away from today's glamour tech stocks which require more and more capital," Scherrer said in the blog post. Gruesome businesses Buffett described "gruesome" companies that investors should avoid in his 2007 shareholder letter. "The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money," he said. Read more: Tens of billions in redemptions, hundreds of billions in losses: Here's a look at how the hedge fund industry hemorrhaged money in March Several of the S&P 500's largest constituents fit some or all of those criteria, Scherrer argued. For example, Netflix's content costs are ballooning, Facebook's customer-acquisition and regulatory expenses are soaring, and Amazon still earns "measly" profits relative to revenue. Therefore, Buffett's recent endorsement of the S&P 500 represents a major, wrongheaded shift away from his guidance 13 years ago, Scherrer said. "It looks to us like Buffett needs to listen to Buffett again," he added. "He is forgetting what gruesome looks like by fawning on the index and some 'obvious' winners of today." Read more: Buy these 14 bank stocks that are jarringly cheap and positioned for extreme moves higher, BTIG saysJoin the conversation about this story » NOW WATCH: We tested a machine that brews beer at the push of a button