Monday, April 27, 2015

Joel Greenblatt on value investing

[11/24/13] Well, actually the secret to value investing is patience, and that's generally in short supply now. The reason it doesn't get arbitraged away is that in typical arbitrage, the usual explanation is that you buy gold in New York and simultaneously sell it in London for $1 more. And what tends to happen in typical arbitrage, there are professionals out there who see those price difference, and so they'll keep buying gold in New York and selling it in London until the prices converge. That happens so fast that individual investors certainly can't take advantage of it, a few very quick institutional investors can.

But if I told you as a value investor that you could buy gold in New York today and sometime in the next two or three years, it's likely you'll be able to sell it for a profit, but you may lose 40% while you are waiting around for that to happen, it's much harder to find someone to arbitrage that away. Time horizons are actually shrinking over the last 20-30 years even. So, things are actually getting better for value investors, not worse. The world is becoming more institutionalized, there is more access to performance information, it's much easier to trade. So, patience is in short supply, and it really makes it much nicer for patient value investors.

If value investing worked every day and every month and every year, of course, it would get arbitraged away, but it doesn't. It works over time, and it's quite irregular. But it does still work like clockwork; your clock has to be really slow.

Dasaro: How do you avoid investing in stocks where the numbers may disagree with the story behind the stock?

Greenblatt: Oh, value traps, right. Well, we're very tough on cash flows, is what I would say. Ben Graham said, buy cheap. Figure out what something's worth and pay a lot less. And Warren Buffett, Graham's most famous student, made one little twist that made him one of the richest people in the world. And he said, if I can buy a good business cheap, even better.

*** [4/27/15]

The point is that Greenblatt’s favorite ideas were the ones where he felt there was very little chance of losing money — not necessarily the highest potential returns.

In the video below, he emphasizes this point. (By the way, thanks to Joe Koster who posted this video—I found it on his site—and Joe also emphasized this quote, which is a good one):

“My largest positions are not the ones I think I'm going to make the most money from. My largest positions are the ones I don't think I'm going to lose money in.”

[The article also discusses Druckenmiller.]

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