The Little Book That Beats the Marketby Joel Greenblatt
Two years in MBA school won't teach you how to double the market's return. Two hours with The Little Book That Beats the Market will.
In The Little Book, Joel Greenblatt, Founder and Managing Partner at Gotham Capital (with average annualized returns of 40% for over 20 years), does more than simply set out the basic principles for successful stock/i>/i>… See more details below
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Two years in MBA school won't teach you how to double the market's return. Two hours with The Little Book That Beats the Market will.
In The Little Book, Joel Greenblatt, Founder and Managing Partner at Gotham Capital (with average annualized returns of 40% for over 20 years), does more than simply set out the basic principles for successful stock market investing. He provides a "magic formula" that is easy to use and makes buying good companies at bargain prices automatic. Though the formula has been extensively tested and is a breakthrough in the academic and professional world, Greenblatt explains it using 6th grade math, plain language and humor. You'll learn how to use this low risk method to beat the market and professional managers by a wide margin. You'll also learn how to view the stock market, why success eludes almost all individual and professional investors, and why the formula will continue to work even after everyone "knows" it.
"...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)
“The book is certainly written simply and the concepts are conveyed compelling” (Daily Telegraph, 29th November 2005)
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.) (Publishers Weekly, November 14, 2006)
"The Little Book is one of the best, clearest guides to value investing out there." (The Wall Street Journal, November 9, 2005)
"...the best book on the subject in years." (Financial Times, May 2006)
"Mr Greenblatt's system is elegant, simple and, on the face of it, very successful." (Investors Chronicle, May 2006)
"…worth a look." (The Business Supplement, September 2006)
Read an Excerpt
This book was originally inspired by my desire to give each of my five children a gift. I figured if I could teach them how to make money for themselves, then I would be giving them a great gift -- truly one that would keep giving. I also figured that if I could explain how to make money in terms that even my kids could understand (the ones already in sixth and eighth grades, anyway), then I could pretty much teach anyone how to be a successful stock market investor.
While the concepts covered in this book may seem simple -- perhaps too simple for sophisticated investors -- each step along the way is there for a reason. Stay with it, and I assure you the payoff for both beginning and experienced investors will be huge.
After more than 25 years of investing professionally and after 9 years of teaching at an Ivy League business school, I am convinced of at least two things:
- If you really want to "beat the market," most professionals and academics can't help you, and
- That leaves only one real alternative: You must do it yourself.
Along the way, you will learn:
- How to view the stock market
- Why success eludes almost all individual and professional investors
- How to find good companies at bargain prices
- How you can beat the market all by yourself
So please enjoy this gift. May the small investment of time (and 20 bucks or so) greatly enrich your future. Good luck.
What People are saying about this
Professor Bruce Greenwald of Columbia Business School, Director of the Heilbrunn Center for Graham and Dodd Investing
"A landmark book- a stunningly simple and low risk way to significantly beat the market!"
Michael Steinhardt, The Dean of Wall Street Hedge Fund Managers
"Simply Perfect. One of the most important investment books of the last 50 years!"
Michael F. Price, MFP Investors, LLC and called "Wall Street’s Foremost Value Investor," by Fortune Magazine
Meet the Author
JOEL GREENBLATT is the founder and a managing partner of Gotham Capital, a private investment partnership that has achieved 40% annualized returns since its inception in 1985. He is a professor on the adjunct faculty of Columbia Business School, the former chairman of the board of a Fortune 500 company, the cofounder of ValueInvestorsClub.com, and the author of You Can Be a Stock Market Genius. Greenblatt holds a BS and an MBA from the Wharton School.
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For a "market virgin" as myself this bood is easy to read, understand and even funny!!
A good foundation for novice investors.
Joel Greenblatt does a good job at expressing the clear advantages towards practicing a fundamental based investment strategy. He cites his own investment record as well as ques some of the famous value investors of the past century to further his claim. Perhaps the most simple method of persuassion used is a formula he created by focusing on companies with high returns and selling at a large discount. Greenblatt focus turns to Benjamin Graham's "Mr. Market" to help readers understand the manic depressive mood swings which allows the market to price securities far above or below the companies underlying intrinsic value. Greenblatt uses the idea of a hypothetical company his son sets up with a friend called Jason's Gum Shops to illustrate several aspects of business and company evaluation, such as earnings yield -- the inverse of the P/E ratio -- and return on invested capital. Lastly, Greenblatt suggest that his magic formula does not beat the market every year but on average after 3 yrs or more of using his system. It uses a hedge by asking the novice to purchase 20-30 companies from the results of his formula and upon holding them for one-year, replace the then current companies with those that rank highest on the current magic formula list. Continue to cycle these companies going forward and voila= "Magic Formula Investing!" It is essentially an index approach using some of the best companies yielding very good earnings. At the very least a solid case for finding a great core of companies to begin ones own research for value based securities. A quick read, if you wish to further validate his record I would critique his long-term record attached to Gotham Capital.
This is one of the many investment / trading books that I've read, but unfortunately NOT kept on my bookshelf. Don't get me wrong -- it's a very readable book that does a good job of teaching some fundamental (no pun intended) concepts.
But the "magic formula" thing worries me. I've done my own research on "magic formulas" that screen stocks based on fundamental measures like P/E, PEG, and Dividend Yield and found them to be not so magic after all. See "Stock Fundamentals On Trial: Do Dividend Yield, P/E and PEG Really Work?"
They seem to work well in a bull market (the onset of which you can determine from a price chart) and then often break down spectacularly when the tide turns (as recent events have shown).
In fact, Joel says on page 6 of the book that:
"If everyone knows the magic formula and everyone can't be rich, pretty soon the formula will stop working."
(and then he goes on to present a magic formula)
The above quote states a good case for "trend following" or "market timing" if ever there was one. Even if the formula does help you to identify good stocks to buy (and it might); do make sure you get off when the music stops.
The author's use of the word "belief" also worries me a little: like, if you believe in the formula then it will work. I'm sure that if enough people believe in it, then it will work, for a while. And maybe if I start believing in fairies, Tinkerbell won't die.
So read this book as I would read The Bible: enjoy it, maybe learn some lessons from it, but don't take it literally.
The Little Book is a short, concise, easy to understand book that sums up the concept of value investing. To beginners, it offers a simple formula for market smashing performance. For experts, it offers a new way of screening for potential investments. With the Magic Formula screen and some additional research (like at MagicDiligence web site), some of the market's best opportunities can be found.
Well Im young and new to all this investing stuff, and I read the book and enjoyed it. Easy and quick to read, I did learn a bit.
Whether or not this book's 'magic formula' delivers the results that author Joel Greenblatt promises, the book itself presents a lucid, simple explanation of investing in the stock market. Unlike many who write about investing in stocks and offer formulas for success, Greenblatt is remarkably honest in his discussion of the difficulty of beating the market and remarkably modest in his claims (although perhaps not quite as restrained in referring to his Web site). We find that the chief merit of this bestseller is not its formula for success (which derives from guru Benjamin Graham's value approach), but rather its clear, step-by-step introduction to the fundamentals of investing for novices. The author makes the market understandable to a child. That is quite an achievement.
Whether you are just getting started or have an MBA this book will help you understand the principles of value investing. The book provides a simple formula to help you find value stocks. Although the formula is easy to understand and use it is not apparent how Mr. Greenblatt is applying it on his Website magicformulainvesting. If you try to use his suggested formula and then compare them to the the results on his site you will most likely get different values. I believe this is because Greenblatt wanted to keep the book simple. However, if you would like to see what I believe is the exact formula visit my tutorial at my website equity-analyst. The tutorial also makes adjustments for normalized earnings which is something that can't be ignored. Even with this minor discrepency this is one of the greatest books on investing to come about in the last 60 years.
I read this book after reading Robert Haugen's work. It's not possible to implement Haugen's strategy unless you pay his consulting firm thousands of dollars to implement his approach, which doesn't work that well even after one's fee is paid. Greenblatt's strategy seems to work extremely well, and it is possible to implement and his web site is free. That Greenblatt's approach is both so much more accessible and much cheaper is really deeply concerning. I'm sticking with Haugen for now.
A very enjoyable read. Greenblatt makes a compelling case for a very simple approach. However, I have been unable to come close to reproducing his results. I am not using the same database, but I would still expect to be in the ballpark, which I am not in many cases. It would be very helpful if Greenblatt were more explicit about his calculations. The FAQ on his website provides almost no help on this. If anyone has been succesful in reproducing his results, I would be interested to know how you are doing it.
Despite calling himself 'The Boston Quant', I would like to point out that 'The Boston Quant's' review was wrong and it is clear that he did not read the book. If he would have, he would know that EV (Enterprise Value) is the market capitalization + debt + preferred - EXCESS CASH. (Actually, as a quant researcher, it is difficult for me to believe he would not know the correct definition of EV even before reading the book. It's kind of like being a Nascar driver and not knowing how to change gears.) Greenblatt gives us a clear definition of all the measures he used in the book. The EV he used was the one I described prior. When it comes to the EBIT, he uses the trailing twelve month EBIT and for Invested Capital, he uses Net Working Capital (= Current Assets ¿ Cash and Short-term Securities ¿ (Current Liabilities ¿ Interest Bearing Liabilities)) + Net Fixed Assets. If I use the same example (1/17/06), Callwave (CALL), in the way Greenblatt described in the book, then I get an EV of $36.40 Million (= $97.90 (MrktCap) + $0 (Debt) ¿ $61.5 (Cash)) and a trailing 12 month EBIT of $6.99 Million. That gives me a EBIT/EV earnings yield of 19.20% and which is close to the same percentage as shown on the Magic Formula website. Don¿t be discouraged by ¿Boston Quant¿s¿ review. Greenblatt¿s book is great.
Having just started out in investing hard earned income for future security, I was expecting to find an easy road to wealth. This book left me with the feeling of being cheated out of $20 that would have been better invested in good sound advice from a reliable market stategist. This book should have been called 'The Little Book of Adkins Investing' -- nothing but hype.
I've used Greenblatt's formula to select the smallest stocks that fit his criteria, and my portfolio is roaring up.
To make such claims of outperformance without verifiable proof is irresponsible. I was looking to backtest this strategy, but after reading the book and checking the website I am unable to back into either EBIT/EV (which should be very easy) or ROC (also very simple). There is simply not enough detail to match the calculations on the site. They claim to be using Compustat's point in time database which I have access to. Are they using twelve month trailing numbers, projected numbers, most recent quarter, or something else? Perhaps there is a transform applied to the ratios, we just do not know. There are not answers to these questions in the book anywhere. Example: Take Callwave (CALL) today (12/12/05) which is on the sites list as recommended today. It has a Earnings Yield of 16% as calculated by the site. Since CALL does not have debt or preferred stock or minority interest then EV should = Market Value = $104.64. To get an Earnings Yield of 16% EBIT must be 16.74. According to COMPUSTAT: Trailing 12 months EBIT = 8.5 Most recent Quarterly EBIT = 1.8 Most recent year-end EBIT = 9.5
What do you get when you mix a strong marketing plan, a well known and successful hedge fund manager, and 100 pages of investing platitudes? Answer: Greenblatt's new book. I hate to be so harsh on the book, because I think Greenblatt's intentions are good. So let me correct myself: If you are under the age of 12 and know diddley squat about how stocks work, buy this book. You'll learn a lot. Now, if you have even a rudimentary knowledge of stock picking -- save your money. Greenblatt says two important things in this book then repeats himself for 100 + pages. All you need to know you could have gotten for free at Morningstar: buy companies with high ROC (return on assets or 'ROA') and high earnings yield (inverse of P/E ratio --the E/P ratio).
I love little books that guide our lives to successful living. Like short proverbs, they are packed with wisdom