Secrets of Investment Success w/ Joel Greenblatt (RWH003)
William Green (00:00:03): Hi there. I’m really excited about today’s episode. My guest is Joel Greenblatt, who’s one of the most successful hedge fund managers in history. Joel famously set up a hedge fund when he was 27 years old and then managed to average a return of 40% a year over the next 20 years.
At that rate, a million dollars turns into 836 million dollars, which I think you’ll agree is a pretty mind blowing achievement. I wrote about Joel at length in my book, Richer, Wiser, Happier. What really struck me, is that he has this incredible gift for simplifying the game of investing. Nobody I’ve met thinks or talks more clearly and logically about how to play this game successfully.
One reason for that, is that he’s not just a great investor, he’s also a superb teacher. He taught a value investing course at the Columbia business school for over 20 years. He’s also written several bestselling books about the art of investing. William Green (00:00:57): I think that process of teaching and writing really helped him to distill in a wonderfully clear and simple way, what works in investing and what doesn’t work.
There’s also one other reason why I’m particularly happy to be interviewing Joel in this episode, as I’m sure you’ll see, he’s just a lovely guy who’s extremely modest and decent and good natured. It’s really impressive to me how humble and grounded he’s managed to remain, despite at all of his success and fame and adulation. Personally, he’s just one of the people I like and admire most in the investing world. William Green (00:01:31): In this conversation, we talk about how he deals with the emotional intensity and stress of investing. We talk about the importance of playing games that you’re truly equipped to win, and the importance of avoiding games that you’re not at equipped to win.
About how he invests his own personal fortune. About what he’s learned from studying Warren Buffett, and more important, I think, from meeting Buffett in person. I hope you enjoy our conversation as much as I did. Thanks so much for joining us.
William Green (00:02:21): Joel Greenblatt, it’s such a delight to be here with you. It’s always a great pleasure to speak with you, and it’s been a while. The last time we chatted was for my book when I interviewed you a couple of years ago for Richer, Wiser, Happier.
Joel Greenblatt (00:02:32): Thanks for having me here today. Appreciate it. William Green (00:02:35): Thank you for coming. One of the things I wrote about you in my book is, I described you as a kind of Codebreaker, who’s drawn primarily to the intellectual challenge of beating the system, that it was never really so much about money. You loved solving puzzles, figuring out different ways to win the investment game, I assume you kind of enjoyed the money too. William Green (00:02:54): I wanted to start by asking you about a few different strategies you’ve come up with over the years, and what we can learn from you about these different ways of winning the game.
I thought we should start with your first winning strategy, of really being super concentrated, which you used back in the 1980s after you founded Gotham Capital. You famously made 40% a year over 20 years with that strategy, and it’s really what made you a legendary investor. I wondered if you could talk about what the strategy was, why it was so stunningly effective, but also why it’s so difficult to execute. Not just analytically, but presumably emotionally given the enormous volatility when you own such a concentrated portfolio. Joel Greenblatt (00:03:36): Well, I appreciate the question and I’m going to have to try to pick that apart a little bit.
I started out my first job on wall street, full-time job. Anyone was doing risk arbitrage, that’s merger arbitrage. Basically, when the deal goes through, as I told you before, you make a dollar or two, but if it doesn’t go through you lose 10 or $20. That wasn’t a very appealing risk reward business for me, so I ended looking around the perimeter of the deal, when there were different pieces of paper given out, or there was a company spinoff before the deal could get done, whatever. Anything that could get me out of risk arbitrage and into something else. Turned out, when companies are going through extraordinary change, there’s a lot of interesting thing that happens.
Sometimes they’re complicated, sometimes little things get thrown away, there’s all kinds of different things. Joel Greenblatt (00:04:24): I started looking at all these different areas, because the risk rewards were so much better. One of the things… They happen a lot, but there’s not hundreds of things you can invest in all at once.
If you examine a situation, a special situation, that something extraordinary is happening in a business and it’s complicated, or it’s obscure, or not everyone’s looking at it for whatever reasons, because the regular analyst who follows that business doesn’t really care about this little piece or whatever it might be, you actually can almost not invest or even gamble. It’s kind of like cheating, where you know what something’s worth, no one else is looking at it, and if you can buy it for a lot cheaper, it doesn’t feel that risky to you. It’s like, “Okay, I think it’s worth 10 bucks and I can pay five, so if I’m wrong and it’s only worth seven, that spend grams margin of safety. I can buy a lot of that.” I think we talked about, years ago, basically, I didn’t size my positions based on how much money I could make.
I took bigger positions, you’re able to take bigger positions in things you can’t lose much money in. If something’s- William Green (00:05:26): Yeah. I remember you telling me you put 40% of your assets roughly in one bet, when there was the post merit split, the spinoff.
You were incredibly bold when you really thought there was a massive margin of safety. Joel Greenblatt (00:05:38): Well, even in that one, I didn’t feel that I was being bold. I felt like I had an opportunity that doesn’t come along that often and I had to take advantage of it. So in the Host Marriott situation, which was a spinoff from Marriott that split into two businesses. One was bad, which was called Host Marriot, which owned a lot of real estate and debt.
But the capital structure was set up so that there was a piece of the business that wasn’t… The debt was owed by a subsidiary. So the parent company, which was Host Marriott, didn’t really have effective debt on the company. They had assets that were assets specific, like a mortgage on a building or something, but they didn’t have debt for the overall company. So actually, I paid $4 for what I thought was $6 worth of assets that were unencumbered by debt. Joel Greenblatt (00:06:24): Plus there was a whole other business that was encumbered by debt, but it was in a subsidiary that could be worth a lot of money.
When I paid $4 for something that was debt free, a debt free $6, plus a lot of other stuff, I didn’t think I was taking a lot of risk. I thought that, “Wow, I just don’t think people see this, this is super complicated and I better take advantage.” It’s kind of like finding one of the best things you’ve ever seen, but putting one or 2% of your portfolio into it. That’s not getting it right, that’s getting it wrong. That’s saying, “I don’t see this very often and now I didn’t really take advantage of it, so I made an extra half a percent,” or something like that.
You really have to take advantage of it and I don’t know that 40% was the right number. It’s true that I did that. Joel Greenblatt (00:07:08): I think I’m a little older, wiser and seen much worse, crazy things happen where I’ve actually made many mistakes.
I have a partner Rob Goldstein who joined me in 1989, and we’ve joked many times during our careers, that if we worked for someone else they would’ve fired us six times already. We make mistakes. So 40%, maybe I popped a number someplace and maybe I got the analysis wrong, that’s true. But I did do that.
You’re right. You called me on that. I’m not sure I would’ve done it that big, but still big. William Green (00:07:38): When you think of the biggest mistakes that you made, not just in those early years.
I remember you saying to me that actually, you didn’t have that many disasters other than obviously, the wonderfully amusing story of Florida, Cypress Gardens. Well, you tell the story, what happened to Florida, Cypress Gardens? Joel Greenblatt (00:07:53): Well, the interesting thing, a Harcourt Brace Jovanovich, which was a publisher, but also owned amusement in parks in Florida, believe it or not, went to buy a very small company called Florida Cypress Gardens, which I remembered as a kid going to, and they had water skiing Santa Claus, during Christmas time, and all kinds of water shows and beautiful gardens. It was a very unique, interesting, and very memorable place to visit when you’re five or six years old. Joel Greenblatt (00:08:18): When I saw they were getting taken over, and this was literally in the first month I went into business for myself. I was pretty nervous.
I was 27 and I had gotten money from a very famous guy and I want to do a good job. I saw this opportunity where Florida Cypress Gardens was being taken over, and there was a nice spread in that deal where I could make a lot of money if it went through. I thought the deal made a lot of sense at the time. I was able to have a big smile on my face and buy Florida Cypress Gardens as one of the first investments I made when I went out on my own. Joel Greenblatt (00:08:48): A few weeks before the deal was supposed to close, unfortunately, Florida Cypress Gardens fell into what’s called a sinkhole, meaning the main pavilions of Florida Cypress Gardens literally fell into a hole that appeared out of nowhere.
Apparently that happens a lot in Florida, I wasn’t that familiar with it, and thank God I wasn’t at Florida Cypress Gardens when it happened, but the wall street journal wrote a real humorous story about it. I was like, “Why is this funny? I’m about to lose my business. I had taken a pretty decent sized bet in the a deal.” Joel Greenblatt (00:09:15): It just tells you, things can happen that you don’t anticipate, that it’s not really your fault.
I’d never even heard of a sinkhole before I read about this happening, so it’s a risk that I… When you’re doing a merger deal, you’re not really saying risk of sinkhole is in your checklist of things to look for, so stuff happens, less kind words for that. It’s a good lesson to learn, especially out of the box. I was sweating pretty good.
They ended up re-cutting the deal at a lower price and I lost money, but not that terrible. I got… Howard Marks, my favorite line from Howard Marks is always, “Experience is what you got when you didn’t get what you wanted.” I always loved that line and that’s what I got in Florida Cypress Gardens, some good experience. William Green (00:09:55): Yeah. It’s a good reminder of just the sheer uncertainty of this business.
Which I think you’ve talked about how you’ve seen that again with COVID, the idea that suddenly you could actually find that all businesses, all these businesses that you thought were pretty steady, compounding machines would close entirely for a year. Nobody could go shop there for example. Joel Greenblatt (00:10:13): Yeah.
I have five kids, a couple of which I’ve taught investing or tried to teach investing too. I was trying to teach investing early 2020, when COVID appeared. I tried to explain, “I’ve been doing this a long time.
I’ve never seen this, never anticipated anything like this. I’ve never seen where they just closed down the world.” Besides the terrible human cost, I’d never seen anything like this. I just tried to explain to them that, “I’m not going to be much help here. I’ve never seen this before, but it is a good lesson to learn that you have to be at least diversified enough, and aware enough, that really bad things can happen.
You have to live to play another day. What’s probably the best lesson to learn, you can’t put all your eggs in one basket, and you can come back from big mistakes as well. Joel Greenblatt (00:11:01): I’ve made big mistakes with big positions as well, and then bad things just happen. Part of what I always thought you get paid for in this business, it’s kind of your stomach.
What I enjoyed about getting into the business was, if you think well, and if you try to figure things out, it’s not really count how many hours you showed up thinking about it, it’s the quality of your thought? In this case, it doesn’t matter how well you’ve thought, other things still can happen. Understanding that, understanding that bad things can happen and preparing to survive to play another day is important. I think that was one of the best lessons. Of course, the market came back fairly quickly, so it wasn’t as painful as it could have been, but we didn’t know that at the time. Joel Greenblatt (00:11:46): I remember watching Warren buffet at his annual meeting, in the thick of things, maybe at the end of March, 2020. I think it was maybe April one or I don’t remember, not far after COVID started.
He didn’t look like this was nothing, and it was a little frightening to see, because it was really staring at the unknown. If you’re looking at the unknown, one of the benefits of working for a long time in this business is, a lot of it is gaining experience, seeing a lot of things, contextualizing things, comparing things to what’s happened in the past and what might happen, and this was fairly unique. William Green (00:12:22): When you look back at those early years, where you had, I think, probably 80% of your assets in six to eight positions.
Do you think in retrospect that you were maybe flying too close to the sun, that was too risky and to some degree you got lucky, or would you still do it the same way? Does that hyper concentrated approach still make tremendous sense to you? Particularly now when markets have probably become more efficient, maybe there are fewer opportunities, they’re more picked over. Does super concentrations still make sense, or is it problematic, because there are just such risks that you’ll get blown out of the game? Because we focus on a handful of winners like you, or Nick Sleep and Qais Zakaria, these people who’ve had very concentrated portfolios. But I remember my friend Guy Spier mentioning a friend of his who had a one stock portfolio and is now managing a cafe.
There is a degree of survivor bias here. I don’t know, would you do it the same way again or was it too much risk? Joel Greenblatt (00:13:14): I don’t consider six to eight names of making up 80% of your portfolio, particularly concentrated. One name for your whole portfolio, that’s pretty concentrated. Once again, I pull out and I’m just going to be spit balling that I’m close here is that, when Warren Buffet said, let’s say you sell your business and you get a million dollars. Then you look around town at a couple hundred businesses and picking six or eight that you can buy at a good price that are in good businesses, with management that you think is going to do a good job, and you did your homework.
Then you divided that million dollars into six or eight businesses that you thought were the best and best price with good futures in town, and well managed. No one would say you’re crazy because you’re thinking of them as businesses. You divided your investment in its businesses. Joel Greenblatt (00:13:57): If you think of them as stocks and pieces of paper that bounce around that you’re going to get quotes on every day, and there’s going to be some volatility involved, as opposed to taking a three or five year horizon in owning those six or eight different businesses.
As a businessman, no one would think you are crazy, they’d think you’re pretty prudent. You took that million dollar windfall from your business and divided it in six or eight places, they’d say, “Hey, you’re a conservative guy.” But put a stock price on it every day, people change the analysis. If you read finance literature, it’s myopic loss aversion, in other words, people don’t like losing, at least getting a quote, 30 to 40% down. Very big institutions invest in private equity, and those are funds that invest in a small handful of businesses and they leverage them up, and no one thinks they’re crazy.
Joel Greenblatt (00:14:47): What they do is, they just don’t mark down their portfolios the way the stock market does. They wait a few months, see what’s going on and pick a number that everyone’s in on it. The person who bought it doesn’t want to get their portfolio marked down, and the person who’s a manager doesn’t want to mark down their portfolio, so I think it smooths the ride. Even though they’re buying leverage equity stubs in a very concentrated portfolio, and everyone thinks those guys are basically geniuses and they make a lot of money, so I don’t see it any different. I just get a quote every day and I got to contextualize that in the right way. William Green (00:15:20): You mentioned before, to some degree as a money manager, you are paid for your stomach, for the strength of your stomach.
You also mentioned that you had a famous investor in that early fund, some people here will know is Michael Milken. Who incredibly, when you were, I think probably about 27 and didn’t have a huge track record, and he was making something like 650 million a year back to you. Can you talk about the difficulty of managing money for outsiders? Obviously after five years, you returned half the money, and after 10 years you returned all of the money, so you were just managing your own money and your partner’s money, and for a few family members and friends perhaps. What’s the pressure that came from those periods where you would suddenly plummet, because you had such a concentrated portfolio? How difficult was it to deal with having outside shareholders like Michael Milken or family members who suddenly would be like, “Oh God, my portfolio just went down 30% in a couple of weeks.” How did you deal with that pressure? Joel Greenblatt (00:16:18): I would say not very well.
Luckily, we had done pretty well, actually, in our first 15 months after I started in 1985. First 15 months, we were up 140%. There was no worry that Mike Milken was going to come and yell at me for that. The problem was is that, after we had done so well, I started in April ’85, so this is July 1, ’86, I call all my siblings and family members and say, “Hey, this is going pretty well.
I think you should put your money in now.” And of course, in the next six months through year end, I ended up losing 17% of their money. They hadn’t participated on the way up. I called them like everybody else, “Hey, this is going well, I think you’re going to take your money now.” And I was down 17%.
That was probably one of the most difficult things that I did, losing people near and dear to me money. Frankly, I never really worry about losing my own money. I figure I life’s long, I think I know what I’m doing. I’ll make it back someday. Joel Greenblatt (00:17:12): But when you’re worried about other people, they’re not thinking that, they don’t know what you’re doing. One of the reasons I can have a concentrated portfolio is because I understand what I own.
If something that you think is worth $10 went from $6 to $5, that’s just not that concerning. You still think it’s worth… If you think you did your work correctly, it’s not so bad. But when you’re losing other people’s money, it’s a different experience and it’s not fun. You always want to do a good job. If you’re wired to try to do well, it feels really, really bad. Joel Greenblatt (00:17:42): One of the reasons after 10 years I gave back all the money was, because I thought that I love this business.
It was really fun trying to figure out the puzzles and making money, and there was enough money to be made if you’re just pretty good at it, have a long life. But the extra pressure of managing other people’s money was a little bit too much. I said, “Boy, I am really silly to take a business I really love and make it something that keeps me up at night.” That just wasn’t working. That calculation wasn’t working for me and I thought that it would take away a lot of the pressure. The real answer to the question was, when I gave back the outside money, did it do that? And the answer is, it did about half of it.
Turns out, still not fun to lose a lot of money for yourself, but not nearly as bad is when you worrying about other people’s money and they trusted you with it. William Green (00:18:29): Have you ever figured out ways to handle your emotions and to become more emotionally resilient? Because I think of someone like Howard Marks, who we talked about before. Howard, I think is… He says that he’s a worrier, but I think also he’s not super emotional.
I always felt… When I was with him, it felt like being in the presence of a most superior machine, with about 50 more IQ point than I had. When I think of someone like Charlie Munger, who said to me at the bottom tick, in March 2009, when he was buying Wells Fargo, he didn’t feel any emotion, any fear. I was wondering if you were wired that way yourself, not to be too anxious, focused on odds, or if there were things that you had to do to get your emotions under control during these very rocky periods? Joel Greenblatt (00:19:12): Yeah. I think what you’re alluding to is, to be a really good investor and have a strong enough stomach, do you have to have a screw loose someplace to be able to handle it? I think the answer is, yes. You have to have a little bit of a screw loose to be able to take those risks.
On the other hand, I do feel the kick in the stomach when I lose a lot of money, but I usually adjust to it in two or three days, try to get my wits about me to take advantage of the opportunity. I think I’m human, at least in that part, where the kick in the stomach, but you kind of get used to it. I think different parts of your career are different. When you’re young, you figure you have time to make it back.
When you’re older, you maybe have the experience to know that it will come back. I’ve seen this before and I’ve seen it not only once but many times, so what do you do here? Joel Greenblatt (00:19:57): I’m not saying you can completely defeat the emotions that are involved and those emotions are very strong. But I do think, at least for me, being able to adjust and count your blessings fairly quickly and say, “Okay, can I live with where I am now? Yes, let’s move forward and try to do it the right way.” One of the best experiences I had, was when I had a summer job and a friend of mine was working for, actually, the head of risk arbitrage at [Drexel 00:20:26]. The guy running that department was about 72 at the time, which I thought was ancient, now I think he was a youngster.
Joel Greenblatt (00:20:32): But I forgot why I had an opportunity to talk to him, but either way, we were taking a walk someplace or whatever and I was saying, I was so upset that I lost money in this thing and how unfair it was, and this thing came out of the blue. This gentleman turned to me and he says, “Well, have you ever made money where you were kind of lucky and it turned out better than you expected.” I said, “Yeah, that happens a lot.” He said, “Well, does it happen more than when the bad things happen?” I said, “Yeah.” And he said, “Well, stop complaining.”
It’s a good way to contextualize, if you didn’t take risk, you couldn’t make extra money. You can put your money in the bank and only take inflation risk or whatever that might be, but at least you know what you have. But one of the reasons you’re able to make money is that the stock market gets very emotional sometimes, creates these opportunities, but it also comes along with pain. If it didn’t, everyone would do it and you wouldn’t have this opportunity.
Joel Greenblatt (00:21:27): Of course, I’m saying something now, not in the heat of the moment, that sounds very logical, but eventually you get there. Eventually when bad things happen in a few days, if you can get your sea legs back and start thinking, “Okay, where are my opportunities? What can I do? Can I trade around in my portfolio? Is there a new opportunity that came up that’s maybe better than what I have?” That’s been the case. Good investors maybe still get kicked in the stomach, but then come back soon enough to take advantage of the opportunities that come there. I think big, big picture, you have to have a little bit of a screw loose to take the pain, especially with a very concentrated portfolio that a number of people I know, pursue. Joel Greenblatt (00:22:06): I did it for a number of reasons. When I’m looking for really, what I would call unfair bets, I don’t have 50 or a hundred unfair bets at a time to take, so by necessity, I have to, when I was running a very concentrated portfolio, take six or eight of them.
Just have a very fine… I think you have to have a very high hurdle. Meaning, to get into the portfolio, it has to be really great. If you own six or eight great things, or at least great bets, that’s more comforting if you actually know what you own. If you don’t know what you own, if you don’t know how to value a business, you’re just going to react to the emotions, because you don’t actually understand what you own.
But if you actually understand what you own, and the premise that you bought those things with is still intact, that’s actually the only way I think you can deal with the emotion, because you realize what you own is still good. William Green (00:22:55): I also wonder if at some level you were always a gambler at heart. From your early days of going to sneak into the dog track, there was something about figuring out- William Green (00:23:03): Going to sneak into the dog track, there was something about figuring out odds and probabilities and asymmetries. Can you talk about that? Because that seems to be such an essential part of your character and the way that you think.
I look at people like Howard Marks as well, who just thinks probabilistically. And I just think, “Oh God, is the future going to be okay? Am I going to be all right?” And there’s this generalized worry or optimism, whereas it seems like people like you and Howard are really calculating the odds in a very conscious, rational way. Joel Greenblatt (00:23:30): I think the answer to your question is both. Wasn’t really calculating odds at the dog track.
I just liked gambling and this was a chance to do it and have something to root for and then I just find fun. With investing, that probably would get old very quickly, that thrill to gamble, especially when you end up losing, which I did in the dog track. But I think most good investors are always calculating the odds. Once again, at least if you’re looking at stocks or security selection, you have to be able to value something and feel that your premises are right or that you’ve made very conservative estimates.
And then if you can buy it a discount to that, or at a fair price relative to that, and you love the business or something along those lines, then it becomes less of a gamble and more of a calculated risk. Joel Greenblatt (00:24:19): And so I think that’s really the way you think about it. Ben Graham called it speculation rather than investing.
Bitcoin is never going to earn any money. Gold, never going to earn any money. So therefore it’s not earning money now. It’s never going to earn any money. So to me it’s a speculation.
I have no intelligent way to value it. So I’m not saying people won’t make money speculating in Bitcoin or gold, it’s alien to me as an investment because I can’t value it. It has no inherent value. It has no earnings. William Green (00:24:53): Do you own any Bitcoin, no? Joel Greenblatt (00:24:55): Sadly no.
Number one, have been wrong in the sense that I didn’t think it would get to these heights, and once it’s here and it becomes accepted like gold or something like that, all bets are off. I don’t know. On the other hand, sticking to what you know is a very important lesson. I don’t feel bad about it. I went to Wharton so I have friends who went to Wall Street. When I graduated school almost no one went to Wall Street, they went to consulting whatever Wall Street hadn’t go on up, in 13 years the market hadn’t gone up and not many people left, but the people who went, I talked and I know there were friends who always told me about their winners and what they did right and everything else and basically stopped talking to those people because it’s a big world out there.
Joel Greenblatt (00:25:38): And of course you’re going to miss thousands of things that would’ve, could’ve, should have bought. But if you just concentrated on the things that you were working on and they do well, that’s really what you have to realize. Bitcoin, I’d throw in as Warren Buffet would say the two heart pile.
Why should I look for the one foot hurdles? That to me is a 10 foot hurdle. I don’t know how to value it. I feel disciplined that I didn’t play. William Green (00:25:57): When you look at the behavior around Bitcoin, I can’t think of a better word than zealotry. You really see this intense belief. It’s almost like a religious belief in Bitcoin among a lot of the owners.
Is there something that’s fundamentally changed here in new paradigm where there really is something new, where this is in the late 90s where we suddenly really realize that these .com companies, even though there was a bubble, there was something real that was going to change our lives? Or do you look at Bitcoin and the other cryptocurrencies and think it’s the other side of 1999, 2000, that it’s just another outbreak of irrational exuberance and this is just how people get? And I’m asked this totally honestly, I’m agnostic here. I don’t know. Joel Greenblatt (00:26:40): Yeah. You’re asking the wrong guy.
I’m in your camp. I don’t know. And I’ve been around long enough to know that I don’t know most things. I know a few things.
And so I stick to investing in the few things that I know. People have tried to make a case for me for the various uses for Bitcoin or why I should stay. And I can’t say I’m completely dismissive. I’m not completely dismissive. I’m saying, “Gee, I really can’t figure this out.” I have no basis on which to say, it’s going to go higher or lower.
Joel Greenblatt (00:27:12): I would have to admit that certain art is very nice and maybe valuable and will continue to have value from really good painters and other pieces of art aren’t or even things that are expensive now may not be good investments. And it’s in the eye of the beholder. I don’t really know.
There’s all kinds of arguments for Bitcoin. Well, there’s plenty of other cryptocurrencies. So is there a limited supply? Is there not a limited supply? Bitcoin actually has a name. And so it’s a brand.
So maybe that stays and maybe it stays like some of the great impressionist developer name and they keep their value over time and they do become a kind of currency. I don’t know. William Green (00:27:55): Do your kids nag you about this? I remember my daughter Madeline at one point saying to me, “Dad, why don’t you own Bitcoin?” I remember Howard Mark’s son telling him, “You need to own Bitcoin.” Howard, I think did open his eyes a bit and say, “Yeah, maybe there’s something I’m not understanding.” And I’m wondering if this is a generational thing where you see pressure from your kids’ generation to smarten up and open your eyes and they’re sort of, okay, boomer attitude towards us old fogies. Joel Greenblatt (00:28:23): I definitely feel okay boomer in many areas, but I’m not going to invest in an area that I understand little about, not very good at predicting.
If I have other choices where I do think I understand the game, I think I’m going to stay there. And I don’t feel bad. One of my partners is, does a lot of computer work for us? He’s a computer programmer. And I think for his wedding, he got two Bitcoins I think when they were at $60 each. I think he still has one of them. So it’s not like I wasn’t exposed to this pretty early on.
It’s just not my game, sorry. There’s not much I can teach my kids and I admitted that upfront. William Green (00:29:00): I actually think there’s a really powerful lesson there to teach your kids which is just the discipline to play games that you are equipped to win.
From all of the interviews that I’ve done with so many great investors over the years that’s so consistent, that discipline to stick with games where you have an advantage. Joel Greenblatt (00:29:18): I think that’s true, but also not crazy in my mind if you want to play these games to put a small portion of your portfolio, maybe to learn, maybe just in case you’re not seeing something, I go to the casino and maybe I’ll lose a couple hundred dollars. After that I feel bad. I know the odds are against me, I’m not counting cards.
And it’s fun to see and look around. And if you limit it to one or 2% of your portfolio, do whatever you want or have a good time and maybe you’ll learn something. I don’t know what to say. But I still consider that discipline, meaning doing with the other 98% what you know how to do.
Joel Greenblatt (00:29:53): I’m not looking down my nose at anyone who tries something new, it’s of the way you learn. I think you just have to size your bets appropriately for speculation and that’s all. I don’t want to be extreme and say, “I’ll never touch that. I’m so disciplined.” I want to be extreme in saying, “Never going to touch that with money I care about. This is my fun money or whatever it might be,” then maybe I’ll learn something and maybe it’ll be a lottery ticket.
I don’t know. Joel Greenblatt (00:30:20): I have a couple of venture capital investments that I’ve made that I know are probably stupid but in their areas, I’m interested in learning and seeing what happens, and there’s nothing like having money on the line to see what happens there. And so I’m still hopeful that things work out and I’m invested in a very small battery technology company that I think may change the world and likely will go bankrupt, that’s going to be fun to watch. And of course, I’m not going to put a big part of my portfolio in it, but I think it’s fun to learn in that area. And so there’s a few contextualize things correctly if you size them correctly. I don’t want to make any hard and fast rules about anything.
I know enough about that. William Green (00:30:59): We talked a bit about your first great mouse trap, this idea of having a concentrated portfolio of special situations, unfair bets, things that were one foot hurdles that other people weren’t looking at. And it struck me in some ways, the second great mouse trap, if I’m thinking about this correctly was when you started to shift towards better businesses at least as part of your portfolio, which I think that evolution happened around 2000, when you reverse engineered what Buffet had done with Coca-Cola and said, “Well, wait a second.
Maybe I can do the same thing with Moody’s. And I wonder if you could talk a bit about that evolution and what you learned from Buffet about what makes a company great. What made you start to think maybe actually, instead of just buying these ultra cheap companies, maybe there’s another way to play this game that is also really effective? Joel Greenblatt (00:31:51): Right.
So just to change that, even reading enough Buffet and following everything he does, really even before 1990, I would say I wanted to buy good businesses. I was just cheap, but I wanted everything. And one of the reasons that I downsized my business after five years and then gave back all the outside capital is because I wanted to own both cheap and good. And it’s too bad if I can’t find that much of this, I’m just going to give back money and just stay in cheap and good.
I didn’t understand good. And I think you properly bring up well, when could I pay what in my mind was a lot of money or fair value for something in a good business? And that’s what you’re bringing up. Moody’s was one of the first that I was willing to pay over 20 times earnings for, at that time was a lot because interest rates were much, much higher.
Joel Greenblatt (00:32:40): It was one of the best businesses out there because it took no capital and they had a brand and a franchise and there were only a few people. There were a lot of good things about Moody’s. I actually loved the business, went back and reverse engineered as you suggested Buffet’s purchase of Coca-Cola. I believe that was in 1990 or so or whatever it was, went back to look at what he paid and made adjustments for the differences in the businesses, for instance Coca to reinvest some of its money to grow.
And Moody’s really didn’t. So you got to keep more of your earnings in Moody’s. So I was willing to pay a little more and made an adjustment for that. Just went to see what am I actually paying for Moody’s today relative to what buffet paid for Coke where he quadrupled his money in the next five or eight years, whatever it was? Joel Greenblatt (00:33:28): And I thought any percentage of that would be pretty good for me, especially if I thought this was that kind of business. It turned out that if you want to put apples to apples, he paid $10 for Coke, when I made all the adjustments, we were paying $13 for Moody’s on this equivalent basis.
But if the $10 was going to quadruple, 13 going to 40 was also pretty good as opposed to 10 going to 40 and thought that was a reasonable premium to pay because these quality businesses that you can buy anywhere close to what you think they might be worth buying. And so just comparing things, it was such a great model to use to get me into paying up for great, great businesses. William Green (00:34:08): So in a sense, it’s a beautiful example of cloning at work. The strategy I talk about in my book from Mohnish Pabrai, where you really reverse engineer what someone who’s smarter, wiser, or more experienced just figured out and you say, “Ah, I don’t need to reinvent the wheel.” That’s what they were thinking.
Joel Greenblatt (00:34:23): Yeah. I think sometimes original thinking is overrated. I’d rather think like one of the smartest guys in the world who’s been the most successful in my area. And if I can copy that seems like a reasonable thing to do.
And so I agree with you. William Green (00:34:37): You would in some sense studying Buffet from a far for many years, but I think I’m right in saying that you didn’t meet him until much later when you went to visit him with a class that you were teaching at Columbia. And I was wondering if you could talk a little bit about that experience and what you learned from actually being in the presence of the master that you couldn’t necessarily learn just from reading books about him or reading his annual shareholder letter. Joel Greenblatt (00:35:01): Well, I’ll tell you, I learned about myself that I’m incredibly shy because I had been looking forward this for a long time. And so I was a little more reserved than I wanted to be at that time meeting my idol in my business, and in many ways, the way he leads his life.
And what I took away from meeting with him, and he took us all out to lunch and we had a great question and answer session and I think plenty of people have seen him do this on film in some way, but actually having it done in person, just with my class, just taking us all out, he handed me his fat wallet, and I got a good picture with him. I would just say that I was stunned at how gracious he was. Someone this successful, how much time and kindness and graciousness he had with the whole class that he had with me, that he really enjoyed it. Joel Greenblatt (00:35:49): And that’s most of what I… I don’t know if there’s a lesson in there, but I guess the lesson I got was, “Wow, this is one of the most successful admired people in the world, and he’s still so humble and gracious.
That’s incredible.” And more than most people you meet who have nowhere near his level of accomplishment and contributing back to society and everything else and yet he was able to be so humble, gracious and sharing. The word role model is what comes to mind. Wow. It was great to see it in real life and that it wasn’t hype, one amazing person.
And if you just do ordinary things, be humble and gracious and goes a long way. And that’s what I walked away with. Just he incredible human being and I admired him even more after I left, which was hard to do.
William Green (00:36:38): And do you think seeing that up closeness had an enduring effect on you? Has it made you think, want to be more like that? Because I think there’s something about seeing the behavior model. That’s hugely powerful. I remember having a similar experience where I went to interview Charlie Munger in Los Angeles, and I went to the daily journal meeting. I’d interviewed him before the meeting and then he does some two hours of question and answers.
And then these group is these disciples hang out for another couple hours and he just keeps answering questions. William Green (00:37:09): And I look at the kindness of this 90 something year old guy who just keeps answering questions. And he always had this reputation for being very graph and brusque and not suffering fools.
And I thought, “God, actually, there’s a deep kindness here in treating these weirdos like me who’ve come 3000 miles to see him.” And that actually, I remember that more than anything that he said I think at that meeting. It was actually seeing this kind of physically ailing old man treating his disciples with… I was embarrassed to say this in the book and so I didn’t actually say it was loud, but it actually was, there was a real kind of generosity of spirit and kindness and love to it. Joel Greenblatt (00:37:48): I walked away feeling the same way about Warren Buffet.
Obviously they’ve been together for a long time and there’s a reason for it. I guess it’s also more unique. Like I said, I know many people less accomplished. Pretty much anyone I know other than those I truly love in my family.
But if we’re just talking about the outside world, I know many people who are less accomplished, are very accomplished but less accomplished who don’t have those qualities. I think about it a lot. I would hope that I at times remember to what an impact it had on me and to the extent that I can emulate any piece of that. Of course, it’s something that I would aspire to do.
But I think these are two extraordinary men. And thank God for that. What role models for me and so many other people they’ve been.
And that’s a nice thing to say about somebody. William Green (00:38:37): I remember Nick Sleep once saying to me in the middle of an interview, he’s like, “Yeah, we’re just lucky to be in the same generation as them. To be alive at the same time, it’s remarkable the role model. So let’s go to the third great mouse trap that Doe Greenback came up with, which I think in a sense it’s not a new mouse trap, it’s a distillation of the others. The magic formula where you took the distilled essence of Buffet and Graham and you came up with really two very simple metrics to say, “Yeah, actually, you don’t need to be that exotic and complicated about this.”
And I wonder if you could talk about that because it struck me, just the sheer simplicity of what you were doing was tremendously powerful. And that’s had a big impact on my own life when I think about the ways in which you were able to play these very complicated games like investing and to simplify. That strikes me almost as a master principle in life, the ability to reduce tremendous complexity to a simple essence that works.
Joel Greenblatt (00:39:36): It’s been interesting, the process of trying to simplify, what was I thinking when I wrote you can be a stock market genius about my years at Gotham and special situation investing? It was actually pretty easy to write because early on I decided, “Well, I’m not going to do a lot of research on this thing. I just want to write down what was I thinking actually at that time? And why did I do that? Because if I didn’t do the research before the book, well, why am I sharing something that I’m doing after I made the investment and so boiling it down? What was I thinking at that time, explaining it in the simplest form started me out there?” I also, after I wrote You Can Be a Stock Market Genius and realized it was really written at an MBA level. I realized that when I started teaching MBAs and realized that boy, “If you didn’t have this background, you weren’t really going to understand what I said in that book.” Joel Greenblatt (00:40:21): And so started me on simplifying things even more because that wasn’t the goal of writing a book to help a lot of future hedge fund managers. It was really to teach investing. And so when I had the opportunity at Columbia to teach, every time I thought of a new lesson to teach or used an example or whatever, I tried to simplify it so that I could explain it better.
And so just the practice of writing and teaching really helped me simplify, simplify, simplify to really get to the essence of what was I really saying. Joel Greenblatt (00:40:51): And back when I was in business school, I wrote with two great friends of mine, Rich Kazina, and Bruce Newberg paper on Ben Graham stock picking. He had his own ‘magic formula’ which was buying stocks only when they were selling below liquidation value, when he always had a portfolio. Ben Graham always had a portfolio of 30 or so stocks that he bought that had those characteristics and showed how that with the market and the way I’d boil that down is, “Well, if you can’t lose money, most of the other alternatives are good. So if you buy it cheap enough and it’s selling it half it’s cash value, tough to lose much more.”
Joel Greenblatt (00:41:25): And so it’ll probably be positive if you’re not going to go grow. And because I had been Buffettised, where I’d rather buy a good business rather than trolling in the drags of the business world, I’d love to own a good business cheap, I figured I’d update that research I had written a paper for the journal portfolio management with my two co-students and friends, and I really wanted to update it. And I was always fascinated by the fact that just buying a pile of stocks that had certain characteristics like Graham did, could make you money.
Joel Greenblatt (00:41:58): Now, I have this updated idea that I’d also want a guy buy good businesses. What if I tested this updated idea like I did back in business school? And computers were a little better off than in 1979. When I went to do this in the early 2000s and hired a good computer programmer that still works with us to test these things. And I just stuck my finger in the air and I said, “All right, let’s find a crude metric for good. And let’s find a crude metric for cheap.”
Joel Greenblatt (00:42:24): So crude metric for good was high returns on tangible capital if you read through Buffet’s letters, that’s really what he’s looking for. And then besides the intangibles, but that’s one of the criteria. That’s one of the hard criteria he’d look at.
And then looking for businesses that are cheap just on a quantitative basis where if you could get 5% in a bank and you could get 10% yield by owning the earnings of this business, and you thought it was going to grow, that sounds better. So I’ll go by that. So the cheaper, the better.
Joel Greenblatt (00:42:49): And so combining those two, I wonder what would happen. Ran it through the computer over a long period of time where we had good data back to 87. And it turned out it worked really well buying cheap and good businesses, and if you did that and put them into deciles, it turned out that the top decile beat the second decile, beat the third decile, beat the fourth decile. Joel Greenblatt (00:43:09): Now, what was interesting about that was that was true.
And you could have a nice looking chart that showed the cheaper and better, the better it did going forward, not backwards but forward, and in order by decile. But it also turned out that if you were doing that kind of investing in the year 2000, where you bought the top decile, the cheapest and the best and you shorted the worst decile, the most expensive and no returns on capital are losing money and you put a dollar into the favorites and you shorted a dollar of the most expensive. Joel Greenblatt (00:43:40): If you did that, you would’ve lost all your money in the year 2000.
Even though, if you had lived past losing all your money, it would’ve reversed over the next few years after the year 2000 as everyone knows, value stocks came way back and the expensive stocks got crushed. And you would’ve made all the money back, but I’ve often said zero doesn’t compound very well. It’s good to know. So in other words, it’s hard to do that. So one thing you could do is just buy the cheap ones and the good one and hope to get a good return.
And in a book that I wrote called The Big Secret that almost no one read, and I always say it’s still a big secret. Joel Greenblatt (00:44:15): So one diatribe I went on in that book that really no one read was looking at, is a manager actually good? How should you measure that? Should you measure it versus a benchmark? Or should you measure it versus let’s say a risk free rate that… If I’m picking a few stocks that I think I can make 15 or 20% on, if the market goes up 25%, but I thought I was taking very little risk buying these things. And I knew these businesses really well and the risk free rate was 5% or 3%, or whatever it was at the time. And I got 15%, am I a bad investor? Or I don’t know what the other 3000 stocks I could have bought are.
I knew what I knew I did my work. I made a 15 or 20% return, very securely did I do well? So no one really picked up on that one way or the other, and the rest of the world is on benchmarking and everything else. And if you can bang out 15 or 20% returns over time, I would say you’re a pretty good investor and it’s very hard to measure what are those risks you took? It has nothing to do with how much the stock bounces around that you bought.
It really has to do with, what was the risk that you would lose? Did you take very little more risks than let’s say the risk free rate? Are you a good investor or not? That was just the discussion I had. And so I think if you buy that top group, you’re in pretty good shape that you’re going to make good money much better than the risk free rate, even on a risk adjusted basis. William Green (00:45:37): I put out a request on Twitter where I said to people, I’m going to interview Joel Greenblatt on Thursday, do you have any questions to him? And I was amazed at the enormous number of responses that I got. One of the recurring things that people ask, a lot I would say, is whether the magic formula has become less effective, whether it still works as well as ever, whether you still believe in it? And also there were a bunch of people who wanted to know, have you looked at things like… William Green (00:46:03): There were a bunch of people who wanted to know, have you looked at things like Tobias Carlisle’s approach? Where he says, “Actually you could tweak Joel’s approach and totally ignore the measure of business quality and just focus exclusively on cheap stocks.
Ignoring return on invested capital. Just focusing on”, I think he says, “Enterprise valued operating earnings. You’d actually do even better because cheap well-financed stocks tend to revert to the mean over time.
So there’s an even simpler approach that might work better than the simplicity of the cheap and good stocks that you were identifying with the Magic Formula.” I know I’ve thrown a lot at you there. Joel Greenblatt (00:46:34): Sure. William Green (00:46:34): But you have a better mind, than I do. Can you update us on whether any of these thoughts are valid? Joel Greenblatt (00:46:39): The fun of The Little Book was that I did not spin the computer thousands of times and say, these two items cheap and good, that worked the best.
I didn’t do that. I said, “Let me think of a crude metric for cheap. Let me think of a crude metric for good. Split them, put together a portfolio and see what happens.”
That was the very first test we ran. It worked well. I wrote a book about it. It wasn’t meant to say, I spun the computer thousands of times and I came up with this and this was the best one. I said, “This makes sense.” Joel Greenblatt (00:47:15): Then we did one test, which I think is pretty valid and it worked incredibly well and in order.
So I agree with the work that cheap also works very, very well. It happens to be more volatile, so it depends how you measure returns or risk. I don’t measure risk by volatility either. Joel Greenblatt (00:47:34): It also turns out that if you’re buying big cash flow generating businesses, usually they’re getting good returns on capital.
Think about it this way, if you open a store and make 30%… If you open a new store and I got to update my examples. But if you open a store and earn 30% returns on tangible capital, that’s pretty good. Not many places in this world you can take money and get 30% return. So maybe you should open another store. Of course, if you can open a store and earn 60% on capital, that sounds better.
But the real question is, can I open a thousand of those stores that earn 30%? And only three or four stores that earn 60%, before that return comes down, then, which is the better long term investment? It has to be good enough return on tangible capital. Joel Greenblatt (00:48:21): So when you’re writing a book and telling people, “Just buy a handful of companies. You want to make sure they’re cheap and good, not like you’re buying thousands of companies and this 200 will do better than this 200 or whatever. You’re not buying 200 companies.”
So I wanted to make sure people were safe and cheap and good. So I still think it’s very valid. I won’t argue with any of the data other than to say that, if you just buy cheap, it does do better, but it’s also more volatile.
Joel Greenblatt (00:48:46): I run portfolios both ways and they’re both good. What I will say is, that we’ve run a portfolio since 2010, I believe, that’s just strictly buying cheap. Well, it’s actually cheap and good. It has an element of return on tangible capital, it’s not 50/50 and that’s done incredibly well. Almost as good as the S&P 500, which is incredible. But it’s a deep value portfolio, which has crushed any value portfolio during that time.
Joel Greenblatt (00:49:13): We also have a lot of data on, I call it the Value 1000. We also have a lot data of just ordering… It’s about 600 or 700 stock portfolio. That’s weighted towards cheapness chosen from the 1000 largest.
But I have a lot of data over history on this portfolio. What it would show you is, the way it’s priced today, the way we look at the S&P and where it’s valuation is, it looks like it’s going to have single digit returns over the next two years. Doesn’t mean that’ll happen. It doesn’t mean that’s adjusted for interest rates. Maybe it’ll do better, because interest rates are lower than historically. But if you look back and use the data for the last 30 years, apples to apples, it says mid-single digit returns over the next two years.
Whereas that value portfolio using the same analysis says, I think it’s going to earn 35% to 40% over the next couple of years, based on past history. So positioned very, very well to do well in the future. I looks to me like it’ll easily catch up to the S&P and maybe exceed it. So that’ll be good.
William Green (00:50:10): So when you use the phrase, you said, “We run a portfolio.” When you think about how you manage your own money these days, given that you’ve come across all of these different, great ways of winning the game. Some very systematic. Some very diversified. Some very concentrated.
What do you do with your own money? Joel Greenblatt (00:50:28): Oh, that’s a great question. So I do both. Most of my money is invested in diversified portfolios, more similar to the way the Magic Formula works.
That’s because that’s a full-time job. We run a big research team, a big tech team, to implement those portfolios. Some of it’s long-short.
Some of it’s long only. I also have concentrated positions in some really good businesses that you would know, like Google and Microsoft. Because some of those top names are businesses like I’ve never seen in my career, that still do not look fully priced to me. That are just buy them and hold them Warren Buffet type choices in my mind.
William Green (00:51:04): So that would be [crosstalk 00:51:05] Joel Greenblatt (00:51:05): So I’m doing both. [crosstalk 00:51:06] But that’s a very passive portfolio. Because really my full-time job is running these diversified portfolios.
It’s not because I think it’s a better strategy. I like them both. I think they’re both full-time jobs and I can only choose one. I did one for 30 years.
I’m doing something else that’s fun for me. I like them both for different reasons. One’s far less volatile.
One still gets very nice risk-adjusted returns. The concentrated portfolios in cheap, good businesses also works incredibly well. William Green (00:51:34): So, if you were going to just tuck away a handful of really good businesses for years, that you think are just vastly superior businesses.
Which in a sense is a little different than your original approach with Gotham Capital. Where you were happier to trade when you found something much cheaper [crosstalk 00:51:49]. Joel Greenblatt (00:51:49): Yeah, but [crosstalk 00:51:50]. William Green (00:51:49): The sort of businesses you could hold now, Amazon, Microsoft, Google, those sort of things.
What could you tuck away quietly for 5, 10, 15 years? And say, “Yeah, I don’t really need to trade much. These are just superior businesses.” Joel Greenblatt (00:52:00): Right.
So the reason why I’m doing that, and one of the reasons why Buffet ended up moving towards that is, if you’re willing to put a lot of work into a, let’s say special situation portfolio, very concentrated, special situation portfolio. That takes a lot of work. To do the kind of work, the deep dive work that you need to understand those businesses and really follow what’s going on as a full-time job, which I don’t have the time to do. Joel Greenblatt (00:52:22): There’s a lot of ways to make money. Another is to buy good, what you view as cheap businesses, because I know how to value businesses.
That I can just leave alone and let them do their thing over a long period of time. The names you mentioned, there’s one or two more that I don’t want to mention, but Google, Amazon, and Microsoft, I have a portion of my portfolio that’s in those and I’m not
2022-04-01 04:45
