The Little Book That Beats
the Market (Little Books. Big Profits)
by Joel Greenblatt
Contrary to efficient-market naysayers,
this engaging investment primer contends that ordinary
stock-market investors can indeed get better-than-market
returns over the long haul. Greenblatt (You Can Be a Stock
Market Genius), a Columbia Business School adjunct
professor, touts a "value-oriented" approach that looks for
bargain stocks whose share price is cheap relative to the
company's profitability. His version is a "magic formula" that
ranks stocks on the basis of two variables—the earnings yield
and the business's return on capital. His Web site,
magicformulainvesting.com, virtually automates the procedure
for novices. Greenblatt offers lots of statistical proof of the
formula's success, but emphasizes the importance of faith in
seeing the investor through inevitable short-term downturns:
"It will be your belief in the overwhelming logic of the magic
formula that will make the formula work for you in the long
run." He conveys his ideas through a lucid if rudimentary and
rather corny explanation of basic investment concepts about
risk, return, interest and business valuation. Although the
fabulous returns he touts seem too good to be true,
Greenblatt's formula is a reasonable variant of mainstream
value-investing methods. Investors seeking a little more
hands-on excitement than the average mutual fund offers won't
go too far wrong following his advice. (Jan.)
Copyright © Reed Business Information, a division of Reed
Elsevier Inc. All rights reserved.
Review
"...a sharply written, anecdote-rich, easy to understand
investing strategy". (Wall Street Journal, August 7,
2006)
"...a rare worthy edition to humanity's investing know-how".
(SmartMoney, May 5, 2006)
There's certainly no dearth of advice on investment. The
best-seller lists are full of books on how to be a successful
investor "in only 15 minutes a week", on how to become an
"automatic" millionaire, and about how to invest if you're
"young, fabulous and broke".
The best book on the subject in years is value investor Joel
Greenblatt's The Little Book That Beats the Market,
which is still a top seller months after its release. Beyond
the credibility that comes from someone whose private
investment partnership, Gotham Capital, has produced 40 per
cent a year returns over the past 20 years, Mr Greenblatt
brings an elegant and simple writing style to what can be a
complicated subject.
He outlines a "magic formula", based on how he invests, that
anyone can use. The formula has only two inputs, a company's
earnings yield and its return on capital. The rationale is
straightforward: buy shares in good businesses, measured by
returns on capital, only when they're available at bargain
prices, defined as a high earnings yield.
The magic formula looks for companies that have the best
combination of earnings yield and return on capital, with each
input weighed equally. An outstanding company with an expensive
stock ranked, say, first for return on capital but 1,999th on
earnings yield, would have the same combined ranking of 2,000
as a low return on capital company within expensively priced
shares, ranking 1,999th in return on capital but first on
earnings yield.
Using this approach to create a regularly updated portfolio of
about 30 stocks with the highest combined rankings, Mr
Greenblatt tested his formula between 1988 and 2004. The
results were remarkable: with only one down year, the magic
portfolio would have returned 30.8 per cent a year, against a
12.4 percent annual return for the S&P 500.
Rather than using the latest 12 months' earnings to calculate
earnings yield and return on capital, Mr Greenblatt and his
analysts try to improve on the rote application of this formula
by using earnings estimates in a "normal" year, one in which
nothing unusual is happening within the company, its
industry or the overall economy.
Mr Greenblatt has created a free website for screening stocks
based on his approach (www.magicformulainvesting.com). In a
recent screen I carried out on the site of the top 100 magic
formula companies with market capitalizations above Dollars
2bn, the top 10companies ranked by market cap were Exxon Mobil
(XOM), Microsoft (MSFT), Pfizer (PFE), Johnson & Johnson
(JNJ), IBM (IBM), Intel (INTC), Conoco Phillips (COP), Dell
(DELL), 3M (MMM) and Motorola (MOT). Now that's an impressive
group of companies.
I own one of them(Microsoft) in my portfolio. Given how
sceptical I am about the tech sector, owning this is a real
leap for me but this is a fantastic business and the stock is
attractively priced. Microsoft has a dominant franchise, some
of the most jaw-dropping economic characteristics ever
achieved, capable, honest, shareholder-friendly management, and
unlike most technology companies, reasonably predictable future
prospects.
I am optimistic about Microsoft's future prospects for a number
of reasons. The company will be releasing in the next year
significant upgrades of its two cash cows, Windows and Office.
Historically, these events have been big and highly profitable
events for Microsoft.
Yes, Microsoft's days of ultra-high growth are over, inevitable
for a company with Dollars 40bn in annual revenues. But it is
highly likely the company will grow substantially faster than
the S&P 500 for many years to come and that its fabulous
economic characteristics will remain largely intact.
At a recent price of Dollars 27, Microsoft, after adjusting for
the company's cash hoard, is trading at under 17 times earnings
estimates for this calendar year.
I don't claim this is screaming cheap but it is close to the
lowest p/e multiple the stock has ever traded at and is, I
believe, an attractive price for a company of its quality and
bright future.
You might wonder if Mr Greenblatt is concerned that
popularising his strategy will mean it will stop working.
"Traditional value investing strategies have worked for years
and years and everyone's known about them," he says. "They
continue to work because it is hard for people to do, for two
main reasons. First, the companies that show up on the screens
can be scary and not doing so well, so people find them
difficult to buy.
Second, there can be one-, two- or three-year periods when a
strategy such as this doesn't work. Most people aren't capable
of sticking it out through that."—Whitney Tilson is a money
manager who co-edits Value Investor Insight and co-founded the
Value Investing Congress. (Financial Times, April 24,
2006)
"...an entertaining two-hour read" (Daily Telegraph,
April 2006)
"...the book unquestionably makes good on its promises."
(SmartMoney, March 2006)
Joel Greenblatt's The Little Book That Beats the
Market is pitched not to the swells of Wall Street but to
the novice individual investor.
Greenblatt, the founder of hedge fund firm Gotham Capital, has
taken what he has learned about investing and written this
skinny, pocket-size book.
His goal: to explain how to make money in terms that even his
five kids could understand. "I figured if I could teach them
how to make money for themselves, then I would be giving them a
great gift."
Greenblatt, a Columbia Business School professor and an
investor for 25 years, says, "I believe I can teach you (and
each of my children) to be one of them" — meaning, a successful
investor.
The Little Book That Beats the Market is simple and
sincere; Andrew Tobias, author of The Only Investment Guide
You'll Ever Need, writes the introduction.
The formula works if you have faith and are patient enough to
follow his guidance — over time, Greenblatt says.
Greenblatt's formula is based on Warren Buffett's investment
principles: Invest in good companies when they are cheap.
According to Greenblatt, his formula historically has beaten
the market for nearly two decades. Although he does not name
the stocks, he claims that from 1988 through 2004, the
high-return/low-price stocks of 30 of the largest 2,500
companies had returns of 22.9% annually.
Simple enough. But how do you find these stocks? "The truth is
you don't need an MBA to beat the market," he writes.
But there's no fairy godmother on Wall Street. "If your
stockbroker is like the vast majority, he or she has no idea
how to help you! They don't get paid to make you money. The
plain fact is you are on your own." That said, you have no
business investing in individual stocks on your own, he
says.
His magic formula promise: "If you just stick to buying good
companies (ones that have a high return on capital) and to
buying those companies only at bargain prices (at prices that
give you a high earnings yield), you can achieve investment
returns that beat the pants off even the best investment
professionals."
He has a free (for now) website, www.magicformulainvesting.com,
which screens companies using his criteria. He advises
individual investors to buy a basket of 20 or 30 top stocks
over the course of a year and turn them over on a strict
schedule, depending on how they perform. He does not mention a
minimum amount to invest.
Be forewarned, though. The formula may or may not work over
"shorter" periods, which can often mean years, not days or
months. Good things come to those who wait and, in this case,
Greenblatt means that it takes three, four or even five years
to show its stuff. After a year or two of performing worse than
the market averages, most people won't stick with it. But
you've got to "really believe in it deep down in your
bones."
Even if you don't drink the Kool-Aid, you will learn about the
technique of value investing from a pro. Greenblatt boils
investment jargon down to what you need to know as succinctly
and humorously as possible. Along the way — and it won't take
you more than two hours tops — you're given a tutorial on
bonds, stock shares and prices, earnings yields, return on
capital and more. The appendix, which is "not required
reading," adds a more detailed, strategic commentary.
It might be hard for less-schooled investors to understand why
the "magic" formula makes sense and to stay with it when things
get bleak, but the hard part is just getting started, he
counsels. That's true for investing, period. (USA
Today, January 16, 2006)
“Greenblatt delivers admirably…it contains one of the
clearest, most entertaining explanations you’ll ever see of the
ideas underlying value investing.” (International Herald
Tribune, 16th January 2006)
Hedge fund manager and Columbia University business school
professor Joel Greenblatt has written a delightful volume
called The Little Book that Beats the Market (Wiley)
that anyone who takes his personal investing seriously should
read. Greenblatt starts his slim volume with an uncommonly
elegant explanation -- written for his children -- of how to
value stocks. He argues that any investor can achieve
higher-than-average returns by investing solely in companies
with a high earnings yield and high return on equity. The
book's biggest flaw is Greenblatt's use of cute, over-hyped
language. He calls his approach to stock picking a "magic
formula" and acts certain his strategy will continue to beat
the market even now that everybody knows about it. (The
Washington Post, December 25, 2005)
“a marvellously clear explanation of the value investing
approach” (Financial Times (also on
FinancialNetnews.com) 10th December 2005)
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