Joel Greenblatt probably needs no introduction, but for those unfamiliar with his background, he is a noted value investor and the CIO of Gotham Asset Management. His style can produce some significant performance swings, but its simplicity and focus on logical metrics has experienced a great deal of success over time. He joins the ETF Think Tank to discuss that investing style and where he thinks the markets could be headed next.
Greenblatt got started on his path at Wharton learning the efficient market hypothesis. He says it didn’t work for him because it contradicted what the professors were teaching. He had a hard time believing that stocks could have a 52-week trading range of $40-100 and still be efficiently priced. He started reading Benjamin Graham and began his path of learning outside of what was being taught in schools. Today, he wants to do the same thing if he feels he has something to add.
Greenblatt’s definition of value is very straightforward – if you value a business based on its cash flow and are able to buy it at a discount, that’s value. Traditional valuation metrics, he has found, have limited value and you shouldn’t just go out and buy stocks with the lowest P/E ratios. Stocks aren’t just pieces of paper; they’re businesses and they should be analyzed individually. When value trading, Greenblatt says you need to be patient and let the trade play out. Sometimes, it could be an out of favor trade, but if you do the valuation work, the market should eventually agree with you.
In terms of today’s environment, Greenblatt thinks the value cycle is just starting. His analysis tends to focus on the cheapest 20% of stocks and he believes that this group is very cheap relative to what we have seen over the past 30 years. Conditions aren’t looking very good today, but things will never look good when they’re this cheap. He still likes the opportunities he sees today.
How does Greenblatt look at debt or buybacks? His process assesses value based on much the company earns outside of capital costs. He incorporates debt through the enterprise value metric and looks at normalized cash flows and pre-tax cash flow yields. In general, he likes buybacks, but the problem is that many companies tend to do them after the share price has already gone up.
Now, Gotham is offering ETFs based on their strategies. Tax efficiency is a big reason why they put them into an ETF. In the big picture, his firm eats their own cooking. You might want to get out of stock, but if it creates a big tax consequence, that could be problematic. ETFs provide an important tax efficiency aspect that can benefit all investors.
Greenblatt says that just because something is cheap doesn’t mean it can’t get cheaper. His company’s research suggests that value is an incredible opportunity right now, but that doesn’t mean that the market can’t drop another 30% from here. Sometimes, investors need to just consider a longer time horizon to let the trade play out. In the end, he is just trying to answer the question of what’s the best way to invest that money.
Other key takeaways:
- “Cheap” is valuing a business and that incorporates growth into the equation as well. His definition is to value a business, try to pay less for it, and try to be right on average. We’re kind of in the insurance business trying to be successful on the entire bucket.
- Greenblatt’s latest book talks about how his company evolved towards Warren Buffett’s way of thinking. He likes to use the cash flow/enterprise value metric, but notes that high returns on tangible capital also work well
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